CONN'S INC CONN
September 08, 2016 - 1:27pm EST by
piggybanker
2016 2017
Price: 8.30 EPS 0 0
Shares Out. (in M): 31 P/E 0 0
Market Cap (in $M): 233 P/FCF 0 0
Net Debt (in $M): 1,167 EBIT 0 0
TEV ($): 1,400 TEV/EBIT 0 0

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Description

We believe CONN has the potential to be a $50 stock in the next 18-24 months, v the current price of ~$8 today.

 

Note: This write-up will be brief, as CONN reported earnings this morning. We believe the company's disclosures were materially positive and wanted to share our views in a timely manner.

 

INVESTMENT THESIS

The key to the CONN investment is that we believe that management will be successful in transforming the Credit business from a PNL drag to a PNL contributor. We believe that the actions take by CONN can turn the Credit business from a $4.00 per share EPS drag to breakeven profitability, with the potential for Credit to be a significant profit generator for CONN.

In our upside case, we assume that CONN will earn over $4.00 in EPS in 2018 (Retail business ~$3.00, Credit business ~$1.00), which at an 12x multiple, would yield a >$50 stock. Our base case assumes ~$2.75 in EPS (~$2.65 Retail; ~$0.10 Credit), which at a 10x multiple would yield a $28 stock, which is still nearly ~4x the current share price.

 

BRIEF OVERVIEW OF CONN

CONN has been written up on VIC three times in the last three years, twice as a long, and once as a short… A quick look at a 5-year chart shows a stock that went from $5 in 2012, up to $80 in 2013 (that is not a typo), and now back to $8 currently. Lets just say the shorts are currently winning, but it may be time for the longs to have their day! 

CONN is one part retailer (selling furniture/mattresses/home appliances, etc through its retail stores) and one part consumer finance company (financing the majority of their customers through installment credit). At the risk of oversimplifying, since 2012, CONN offered more and more credit to its customers, which allowed them to generate more sales and open more stores, which allowed them to extend more credit, which allowed them to generate more sales and open more stores… and so on and so on… it was a virtuous cycle that repeated until it didn’t… ultimately, CONN had extended too much credit to too many people and the Credit side of their business started to have real issues a few years ago.

As it stands now, CONNs Credit business, which historically had been consistently profitable, is now losing over $4.00 per share in GAAP earnings. CONNs Retail business has largely been subsidizing the Credit business, with EPS of ~$3.50. Still CONN today is unprofitable, and the stock price (near the lows) clearly reflects that.

About a year ago, new management team was brought in to turn around the operation.  We believe that the efforts that the new management have taken are starting to bear fruit, and that the Credit business can return to breakeven (or even a profit), with minimal impact to the Retail business. We believe this will result in dramatically improved earnings power for CONN, which should result in a dramatically improved share price.

 

CREDIT BUSINESS DETAIL

Below we detail a snapshot of what CONNs credit business looks like currently. CONN has $1.55bn in receivables (loans to customers), which generate $286mm of interest and fees, but are offset by more than $450mm of operating expenses, provisions and interest expense, leading to sizeable losses.

 

        CURRENT
        $ % of Rec
Average Receivables   1,544 100%
           
Interest and Fee Yield   286 18.5%
           
SG&A       135 8.7%
Provision       224 14.5%
Interest       100 6.5%
           
PBT       (173) -11%
NI       (121) -8%
CREDIT EPS     ($3.9)  
CREDIT ESTIMATED BVPS   $4.5  
CREDIT ESTIMATED ROE   -88%  

 

 

Below is a snapshot of how we think CONNs credit business will look in our base case. We believe that through a combination of increased fees, lower provision expense, and lower interest expense, CONN can bring the Credit business back to breakeven.

 

 

        CURRENT   PF--BASE
        $ % of Rec   $ % of Rec Bps Ch
Average Receivables   1,544 100%   1,544 100%  
                   
Interest and Fee Yield   286 18.5%   399 25.9% 735
                   
SG&A       135 8.7%   150 9.7% 97
Provision       224 14.5%   185 12.0% (250)
Interest       100 6.5%   65 4.2% (227)
                   
PBT       (173) -11%   (1) 0% 1,115
NI       (121) -8%   (1) 0%  
CREDIT EPS     ($3.9)     ($0.0)    
CREDIT ESTIMATED BVPS   $4.5     $4.5    
CREDIT ESTIMATED ROE   -88%     -1%    

Interest and Fee Yield:

When CONN reported earnings TODAY, they made the following statement:

"During the second quarter, we received the regulatory licenses in the state of Texas required to offer direct loans at higher APRs to customers financed through our in-house credit offering. The direct loan program is expected to be implemented across all 55 Texas locations by the end of this fiscal year. The state of Texas represents many of our strongest markets and approximately 70% of our recent originations, which under our legacy offering had a maximum equivalent APR of approximately 21%, compared to 30% under our new direct loan program.

In addition, CONN is increasing fees on an additional 25% of receivables. Our simple math is that 95% of receivables will reprice over time at a 8-9% increase, yielding CONN an additional 700-800bps benefit in yields. The company confirmed this on the conference call, stating they expect a 600-900bps increase in yield from these actions. Again note that this is new information as of the press release this morning, and we believe is a game-changer for CONN.

 

Provision:

CONN started making significant underwriting changes a year ago to tighten credit. Just the opposite of extending more credit, which had an immediate boost to retail sales, but a longer-tailed impact on credit costs, these changes have impacted same store sales immediately on the negative side, but the benefits of a reduced provision have yet to manifest themselves. We believe that provision expense should decline, and management is targeting a 10-12% cumulative loss rate on future vintages. We use a 12% loss rate as a pct of average receivables in our analysis above.

 

Interest:

Last year, CONN made the choice to diversify their funding from bank loans to ABS issuance. Being a new issuer to the ABS market, CONN had to pay higher rates to get their initial deals done. As CONN 1) becomes a more seasoned issuer in the ABS market, and 2) credit costs normalize, we would expect interest costs to decline meaningfully. CONN management has stated their goal is to drive ABS costs down to 4.5-5.0% over time. We use the upper end of that range, 5.0%, multiplied by 80% LTV on receivables, to get an average rate of 4.2% on receivables.

 

Put all those pieces together, and a path to breakeven for Credit becomes visible.  Assuming slightly less conservative assumptions (higher yields, lower losses, lower interest expense) we can arrive at >$1.00 in EPS for Credit in our upside case

 

CONN VALUATION

See below for our valuation framework on CONN. We believe that CONN can produce over $4.00 in consolidated EPS in our upside case, which at a 12x multiple, would yield a $52 stock.

 

 

      Up Base Dn
CREDIT          
Avg Receivables   1,550 1,550 1,550
Yield     27% 26% 24%
Provision   10% 12% 13%
Credit Net Revs   264 217 171
Credit Opex   150 150 150
Credit Interest   56 62 81
Credit PBT   58 5 (60)
Credit NI     40 4 (42)
Est Credit EPS (FY18E) $1.31 $0.11 ($1.37)
Multiple     12.0x 10.0x 8.0x
Est Credit Value   $16 $1 ($11)
           
RETAIL          
Store Base   112 112 112
AUV     10.5 10.0 9.5
Product Sales   1,176 1,120 1,064
Total Retail Sales   1,316 1,260 1,204
EBIT Margin   10.0% 9.0% 8.0%
Retail EBIT   131.6 113.4 96.3
Retail NI     92.1 79.4 67.4
Est Retail EPS (FY18e) $3.00 $2.58 $2.19
Target Retail (X)   12.0x 10.0x 8.0x
Est Retail Value   $36 $26 $18
           
Target Px (CONN)   $52 $27 $7
Up/(Dn) $   44 19 (1)
Up/(Dn) %   583% 256% -13%
Prob     50% 0% 50%
EV     $29 285% up/(dn)
           
Consol EPS   $4.31 $2.70 $0.83
Current (x)   1.8x 2.8x 9.2x
Implied (x) at Tgt   12.0x 10.0x 8.0x
Implied ROE (%)   26% 16% 5%

The author of this posting and related persons or entities ("Author") currently holds a long position in the securities mentioned above. The Author makes no representation that it will continue to hold positions in these securities. The Author is likely to buy or sell long or short securities of this issuer and makes no representation or undertaking that Author will inform Value Investors Club, the reader or anyone else prior to or after making such transactions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note. The views expressed in this note are the only the opinion of the Author.  The reader agrees not to invest based on this note and to perform his or her own due diligence and research before taking a position in securities of this issuer. Reader agrees to hold Author harmless and hereby waives any causes of action against Author related to the above note.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

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