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    Introduction/Thesis: Metric 2008 2009 2010 2011 2012

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    bobdylan12345
    Conn's faces challenges from larger competitors in the low-credit retail market. To compete, Conn's has relaxed its lending standards, selling more expensive items to higher-risk customers. This strategy has led to deteriorating credit quality, as evidenced by rising delinquency rates and losses. However, Conn's stock currently trades at a high valuation not supported by its weak fundamentals. The report recommends shorting Conn's stock, as it is unlikely their unsustainable lending practices can continue driving growth to justify the current price.

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    Introduction/Thesis: Metric 2008 2009 2010 2011 2012

    Uploaded by

    bobdylan12345
    34 views2 pages
    Conn's faces challenges from larger competitors in the low-credit retail market. To compete, Conn's has relaxed its lending standards, selling more expensive items to higher-risk customers. This strategy has led to deteriorating credit quality, as evidenced by rising delinquency rates and losses. However, Conn's stock currently trades at a high valuation not supported by its weak fundamentals. The report recommends shorting Conn's stock, as it is unlikely their unsustainable lending practices can continue driving growth to justify the current price.

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    Conn

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    Conn Report

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    Conn's faces challenges from larger competitors in the low-credit retail market. To compete, Conn's has relaxed its lending standards, selling more expensive items to higher-risk customers. This strategy has led to deteriorating credit quality, as evidenced by rising delinquency rates and losses. However, Conn's stock currently trades at a high valuation not supported by its weak fundamentals. The report recommends shorting Conn's stock, as it is unlikely their unsustainable lending practices can continue driving growth to justify the current price.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    34 views2 pages

    Introduction/Thesis: Metric 2008 2009 2010 2011 2012

    Uploaded by

    bobdylan12345
    Conn's faces challenges from larger competitors in the low-credit retail market. To compete, Conn's has relaxed its lending standards, selling more expensive items to higher-risk customers. This strategy has led to deteriorating credit quality, as evidenced by rising delinquency rates and losses. However, Conn's stock currently trades at a high valuation not supported by its weak fundamentals. The report recommends shorting Conn's stock, as it is unlikely their unsustainable lending practices can continue driving growth to justify the current price.

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    of 2

    Report on Conns (CONN)

    Introduction/Thesis
    Although Conns has achieved double digit same store sales growth and margin expansion over the past few years, the
    companys paper profits are driven by credit deterioration as it sells more and more expensive items to people who
    cant afford them. This suggests that the fundamentals of the business are deteriorating and the company is failing on an
    actual cash flow basis. Despite Conns recent setback in 2013 Q2 results of high delinquencies due to procedural lapses
    following collection software upgrade, the companys stock price has mostly recovered from that 25% drop in
    September 2013 and is trading near $75 now. This price implies an extremely high valuation based on analyst estimates,
    suggesting 25x forward EPS, and 14x forward EBITDA. The high growth priced into Conns stock is unlikely to come to
    fruition, as the companys growth is supported by the unsustainable business practice of attempting to thwart
    competition by relaxing its lending standards. Given these fundamental issues with the company and the richness of the
    valuation compared to its main competitors that trade closer to 15x EPS and 7x EBITDA, I think Conns should trade at
    much lower multiples and recommend the company as a compelling short idea.
    Conns faces intense competition from bigger names in the industry
    Conns faces intense competition in the low-credit-score big box retailing market, such as Aarons and Rent-A-Center,
    not to mention the higher-end stores such as Sears, Wal-Mart, and Target. Focusing on just the low-credit-score end of
    the market where Conns primarily competes; the company is at a fundamental disadvantage. Its brand is not as large
    popular as that of Rent-A-Center or Aarons, and it has a much smaller footprint. Conns has 55 stores total, with 38 in
    Texas, while Rent-A-Center and Aarons have 290 and 229 stores in Texas alone. Most sell side analysts appear to view
    Conn as poised to expand its operations aggressively outside Texas, which may occur given the company would build
    stores in states where it does not face interest rate caps on its loans. Given the companys rather static store count
    number for the past 5 years, store growth is possible if they are able to execute properly.
    So what is Conns strategy to compete?
    Given this competition, the company has implemented a differentiated strategy to set it apart from its peers. Conns is
    expanding its margins by selling higher brand goods to its customers and booking income statement profits, financing
    their purchases with the companys own balance sheet, and then trying to collect on these loans afterwards. We can see
    this strategy reflected in the companys financials. The company has seen an uptick in same store sales, as Conns is
    willing to sell premium goods to customers, whereas its competitors are likely not selling such high-end goods to low-
    credit customers. The company has also seen increased retail gross margins by expanding the mix of higher-end
    products it holds in stores. The company calls this strategy: combining our retail stores and supporting services with
    financing alternatives that provide our customers the ability to make aspirational purchases. In essence, Conns is
    pushing premium brand goods onto its customers.
    Metric 2008 2009 2010 2011 2012
    Stores open at end of period 76 76 76 65 68
    Same stores sales growth 2.0% -13.8% -9.6% 2.8% 14.3%
    Retail gross margin 27.5% 25.2% 26.5% 28.7% 35.2%

    Selling expensive goods to low-credit customers has led to deterioration in credit quality
    When companies sell premium goods, they have to make sure that their customers can afford the products. Conns has
    focused so much on booking accounting profits (the revenue is recognized when they make the sale) that it has
    overlooked that its customers are not repaying their receivables. The companys underwriting standards have been
    decreasing significantly over the past 5 years. Conns has increased the percent of its sales financed by its own balance
    sheet by 10 percentage points, such that 70% of its sales now risk the companys own capital. Conns also accepts lower
    Report on Conns (CONN)


    down payments from customers that owe the company more money per account. We can see that this has increased
    the days sales outstanding to increase more than four times over since 2008. It now takes 178 days for the company to
    collect on its sales. Finally, Conns has changed its accounting practice of what constitutes delinquent loans. I cant really
    speak for the companys intentions, but this rather obfuscates the credit quality of its customer receivables portfolio.
    Nevertheless, there are other metrics that we can look at to assess credit quality. Net charge-offs have increased over
    3.5 percentage points over the past 5 years, which is a huge indicator of credit deterioration.
    Metric 2008 2009 2010 2011 2012
    Percent of retail sales financed, including down payment 67.2% 62.5% 61.2% 60.4% 70.9%
    Average down payment 8.2% 6.9% 5.3% 5.3% 3.2%
    Average outstanding customer balance 1,401 1,335 1,285 1,329 1,535
    Days Sales Outstanding 38.52 68.08 174.24 166.01 178.83
    % of balances 60+ days past due to total outstanding balance 7.3% 10.0% 8.6% 8.6% 7.1%
    Net charge-offs as a percent of average outstanding balance 4.4% 5.0% 7.3% 7.5% 8.0%

    The credit deterioration is most evident when we look across the receivables portfolio. If you look down the columns, it
    is clear that newer loans have increasingly higher cumulative loss rates. The company booked higher provisions for loan
    losses in 2013Q2 as a result of not being able to contact customers with delinquencies. While this may have been a one-
    time event, provisions were even elevated in 2013Q1 before this fiasco. Given the companys recent push for greater
    sales backed by these receivables and the looseness with which they offer financing, I think it is likely that the company
    will soon see tremendous losses, forcing it to book higher provisions for losses.

    Risks to thesis
    The company has improved its re-aging policy, such that they cannot re-age loans as much as before. My analysis could
    be wrong if there are actual improvements in the delinquent receivables that have yet to flow through to charge-offs.
    Furthermore, perhaps there is a niche market for low-credit-score customers to buy premium goods on store credit and
    pay them off at sufficient rates to justify the companys risk
    Valuation
    Given the companys fundamentals and the risks to my thesis, I value Conns at 15x 2014 estimated EPS of $2.83, in line
    with the average multiple attributed to its peers. This implies a value of approximately $42, or 44% downside.

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