I once knew a guy who hated to own things. He didn't like owning a car. He didn't own a house. He didn't own his TV, or washing machine, or dryer, or even his furniture. For a while, I thought he was in the Witness Protection Program. You know, just in case he suddenly had to flee, he wouldn't leave anything important behind. Then I learned it was just because, well, he didn't like to own things. He felt like it weighed him down.
That's when I learned about Rent-A-Center (Nasdaq: RCII).
Later I decided to check into Rent-A-Center to see if it might be a stock I'd want to own. Going in, my hypothesis was that I'd find a capital-intensive business because the company would have to buy all those appliances, have delivery infrastructure, have a lot of rental and labor overhead, and deal with repossession. I assumed most customers had weak credit, though, allowing the company to charge hefty monthly rental fees that would offset the costs.
Look, Ma! I'm a genius!
Well, maybe not. It wasn't that hard to figure out, but I gave myself a pat on the back anyway.
Yes, Rent-A-Center is a profitable business, but not quite as profitable as I was hoping to see. I was actually rubbing my hands together greedily, expecting net margins of 20%.
Wrong.
Revenues for full-year 2008 and 2009 were $2.88 billion and $2.75 billion, respectively. But operating expenses and costs of goods sold ate up a lot of that revenue, leaving operating margins hovering around 10%. Labor is the real punisher here -- it's 57% of revenue.
The company helps pad revenue by offering financial services products, such as short-term secured and unsecured loans, debit cards, check cashing, tax preparation, and money transfer services in about 10% of its stores. This puts Rent-a-Center in competition with the likes of Advance America (NYSE: AEA), Cash America (NYSE: CSH), and Dollar Financial (Nasdaq: DLLR). While this sector is mature, Rent-A-Center has the advantage of having these services in-store as an adjunct, so it's incremental revenue.
Rent-A-Center does generate profit -- $140 million in 2008 and $168 million in 2009 -- and it's got interest expense well covered. The company realized its debt load was too great and paid down debt, such that interest expense declined year-over-year to $27 million, from $66 million.
In addition, the company managed to trim over $100 million in overhead, which is why net income rose in 2009 even though same-store sales were down 3.5%. So my hands are now warm and toasty from all the rubbing together, but I am still dismayed by the 6.1% net margins.
So is Rent-A-Center worth my investment?
Overall, the company has good things going for it. It owns 3,000 stores, representing a 35% market share in the U.S. So it's the big leader, with Aaron's (NYSE: AAN) far behind with 1,700 stores.
It makes money. Rent-A-Center generated about $261 million in free cash flow over the past year. Though it carries a lot of debt, over $700 million, its free cash flow reduces that concern. So it's a fine, healthy business with very little regulatory concern.
That's a good argument to own.
On the downside, same-store sales are off in this down economy. The company says it expects comps to increase by 1% this year. But it is also guiding for net income to be between $2.35/share and $2.55/share vs. $2.52/share in 2009. So for the moment, we're looking at a no-growth or negative growth company, trading at a P/E around 10 based on recent prices. Analyst consensus targets $2.68 in 2011, just an 8% increase over 2010.
That's a better argument to rent. And that low growth is not even padded with a hefty dividend, such as that provided by a high-yield, low-growth company like Altria (NYSE: MO).
I see a mature company here, and it's not the place I want to put my money. However, I would consider it a value proposition if the stock were to revisit the 2008 lows around $13 from its current price of $24.
Looking for home run stocks? Jim Royal has a few that you never want to sell.
