Description

The last write-up of Conn’s, Inc. was in Sept 2016 and provides a good summary for those interested. This write-up will be brief. At the time of the Sept 2016 write-up, the company, under previous management, had focused on selling high-end electronics and appliances to newer subprime customers without worrying enough about the collections. The Credit business blew up and the current management team has done a good job delivering on their plan of +1,000bps improvement in the Credit business getting it to breakeven or better. Prior to COVID-19, Conn’s had largely realized the Base Case referenced in the 2016 pitch.

Unfortunately, just when the Credit business was operating as intended, their retail business hit some major hiccups – first with electronics and the rapidly falling price of TVs last year and then COVID-19. Investors don’t want to touch a subprime lender when their Credit business is looking weak (which is fair) or a retailer pretty much ever (which might also be fair).

The variant perception is that a number of credit-focused businesses (from Conn’s to Carvana/CarMax to General Motors and maybe even Apple) are in the loan origination business. Conn’s uses nice home appliances and fancy electronics to lure subprime customers into loans. In their defense, the Conn’s customer receives utility from this relationship as well:

i)              Conn’s customers are under-banked and Conn’s effective rates are similar to credit card APRs;

ii)             Lower cost to customer than Rent to Own option (Rent-A-Center or Aaron’s); and

iii)            Merchandise is of higher quality than buying used or rent to own.

From the Company’s perspective, the business model generates very attractive returns on invested capital, when the credit book is appropriately managed (just like Credit Acceptance, OneMain, Santander, etc.). Prior to COVID-19, the Company had been targeting fairly aggressive growth of the store base, see company presentation - https://ir.conns.com/static-files/0be29d13-d6d6-400b-90ce-4f7caf2e80cf

Recent commentary and earnings results from major US Banks as well as other subprime lenders (i.e. OneMain) suggests that delinquencies have been low and (re)payments high. As well, commentary from retailers suggests that stimulus dollars were directed toward stay-at-home and outdoor/athletic categories. Conn’s should be a modest beneficiary, as they were in the first quarter of their fiscal 2021 when e-commerce sales and credit applications increased meaningfully. We expect the sales and new loan origination to be muted given the economic environment and prudent focus on credit quality. As such, Conn’s should be generating excess cash and waiting to see the health of their customers before underwriting much new business.

At the current market price of 87% of par, the Conn’s 7.25% bond is a decent risk/reward offering a 15% YTM with limited duration. There is significant insider ownership of the equity, which aside from decent cashflow and long-term/normalized fundamentals, makes it unlikely that the issuer will default prior to or at the bond’s redemption.

Balance Sheet (I was undable to paste picture - see highlights below, but worth pulling up the filing - see Pg. 3 of 10-q)

Cash and equivalents: $287m

Restricted cash (includes bankruptcy-remote VIEs): $73.5m

Current Customer A/R: $548.2m

LT Customer A/R: $530.4m

Credit Facility: $336m

Senior Notes: $227m

ABS: $617m

Shareholders' equity $496m

Debt Profile  - (I was undable to paste picture - see highlights below, but worth pulling up the filing - see Pg. 13 of 10-q; ABS notes can be viewed from the Company’s website - https://ir.conns.com/asset-backed).

The revolving credit facility was drawn as a “precautionary measure” in response to COVID-19, similar to a number of other companies. And Conn’s entered into an amendment to their revolving credit facility to waive the interest coverage covenants for fiscal 2021. (I was undable to paste picture - see highlights below, but worth pulling up the filing - see Pg. 17 of 10-q)

Scenario 1: Golden Swan

Conn’s equity is trading at ~0.7x BV and could get back to ~$2.50 EPS in 12-18 months, which implies a +15% RoE. In that scenario, the equity should be worth BV, or more, and the bonds might trade at or through par (as they did in 2018, 2019 and early 2020). This scenario implies a +20% IRR on the bonds.

Scenario 2: Calendar 2021 a bit dicey but Conn’s equity survives

Conn’s should have an opportunity to refinance the bonds in 2020/21 assuming fundamentals don’t deteriorate meaningfully and/or Warren Stephens (and his investors) who owns +20% of the equity want to keep the post-COVID option alive. The ABS market does not appear to be open yet but credit markets have been, albeit at higher funding costs, for lenders. Base case is bonds mature or get refinanced and ~15% IRR.

Scenario 3: Credit deteriorates rapidly, second round of shutdowns, prolonged recession, etc. 

The current economic situation is unprecedented and highly uncertain. While losses and delinquencies are largely known for 2020, no one knows what 2021 might look like based on COVID-19, additional stimulus, employment, etc. Conn’s second quarter earnings and any guidance should provide better handle on the situation but will need to be monitored through 2021. Given the extreme monetary and fiscal stimulus, we would think that the March / April lows ~$55-$60 provide an extreme downside scenario. However, one could obviously construct a much more draconian scenario for a subprime lender.

Catalyst

Maturity