We all remember the late 1990s, when the markets were overcome by "irrational exuberance." Aaron Rents (NYSE: RNT) may have caught a bit of this dread disease by increasing its store base by 16% during the 2007 fiscal year. The consequences shined through in the fourth-quarter results.
Top-line growth remained healthy, with comparable sales up 3.9% in company-owned stores and 15% in franchise locations. But profitability has stalled at the company. While beating analyst estimates by a penny, earnings per share fell 20% from the previous year's quarter.
The culprit? Expansion growth expenses skyrocketetd 20% for the quarter and 16% for the full year.
As management explained in the conference call, new stores have a slow growth curve -- payroll and rent expense can cause a loss of $150,000-$200,000 before the store hits its first month of profitability. This is in contrast to new Wal-Mart (NYSE: WMT) or Costco (Nasdaq: COST) stores that enjoy an opening honeymoon period of high sales.
There is a silver lining to the bad news, however. Management does realize that it bit off more than it can chew and intends to slow its growth rate in 2008 to 10% to 13%. Rather than continued rapid store base growth, it plans to focus on "increasing revenues in existing stores, and improving overall profitability."
Still, the pain is expected to persist for a while longer. First quarter EPS guidance is $0.38-$0.43, well below the $0.48 it earned last year. And while full-year 2008 guidance calls for a 14% increase in sales, profitability expectations form a wide range, from down 4% to up 6%.
It's tough to determine whether this industry is a casualty of the housing downturn. A comparison to rival Rent-A-Center (Nasdaq: RCII) suggests maybe it is, as it has fallen on hard times recently, announcing the closing of 280 stores and a fourth-quarter restructuring charge of $39 million.
The CAPS community has mixed views, ranging from liking the rent-to-own business model, to concern over the financial health of the industry's lower-income demographic. I think Aaron Rents is a well-run company that just got overly exuberant over growth. For now, however, I think it's prudent to watch whether all those new stores can generate profits in 2008.
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