Rent-to-own chain Rent-A-Center (NASDAQ:RCII) may, at first glance, look like an attractive business to own. It assumes recurring, predictable cash flows as the company effectively makes high-interest loans and performs well in times of both economic strife and prosperity. The cash flows are in fact distributed back to shareholders, partially in the form of a 2.3% dividend. In its earnings report released on Monday, the company fell short of expectations -- sending the stock down and implying lower valuations that were already appealing to many a value seeker. It's true: Rent-A-Center as a stock is appealing, but investors need to look more closely at the actual business to understand why it may be a risky investment.
Rent-A-Center, the consumer durable goods lessor, saw its net revenues climb just over 2% to $754.8 million, while bottom-line earnings fell substantially -- from $0.67 per share in 2012's third quarter to $0.51 per share. Deliveries trended up more than 7%, but same-store sales actually declined 0.8%.
The company's core U.S. business saw a decrease in sales, though it was compensated for -- courtesy of the company's new RAC Acceptance program. Acceptance allows shoppers who want something at a non-Rent-A-Center store (and that they essentially can't afford) to get the item. Rent-A-Center buys the product and then leases it out to the customer.
Management isn't too concerned about the drop in the core business, though, as the deliveries figure indicates continued demand for the service itself. Still, what angered investors most was the lowered full-year guidance. For fiscal 2013, the company expects to earn $2.80 to $2.85 per share. It had previously forecast for $3.03 to $3.15 per share.
Rent-A-Center's financial woes may be of a short-term nature, and thus this week's sell-off could indicate a buying opportunity for the business. The thing is, it isn't the company's financial statements that should make investors think twice.
Rent-to-own businesses tend to be based in lower-income areas and advertise to individuals unable to buy the goods they want -- instead offering them what amounts to an extremely high-interest loan. Rent-A-Center strongly argues that it does not provide "loans," as that would subject the company to stricter regulations -- such as putting an effective APR rate on its products.
At the moment, there is no immediate regulatory issue pressing Rent-A-Center, but that could change in the future. Investors compelled by the apparent value in the stock need to look deeply into the difference between a lease and a credit sale. As of now, Rent-A-Center's business is considered a leasing one. Some state regulators have implemented stricter rules on their own. New Jersey, North Carolina, Wisconsin, Vermont, and Minnesota all require rent-to-own businesses to be treated as loan providers. The U.S. Department of Defense (obviously not a regulatory body) has said before that rent-to-own businesses are predatory credit lenders and dangerous to the consumer.
If a change in federal law were to be implemented, Rent-A-Center's business could erode quickly as consumers are awarded the protections and rights associated with traditional loan businesses. Again, management has not expressed too much concern about any pending legislation or legal issues. It should, though, make investors think twice before taking a position in this seemingly attractive investment.