Aaron Rents Can Benefit from This Credit Environment

In the search for stocks that have the potential to benefit from a protracted recession, we want to highlight an undervalued stock in the rent-to-own segment. Aaron Rents (RNT), an Atlanta based company, was being pummeled Tuesday, down more than 16% as of this post. This appears to be in reaction to the earnings guidance issued Tuesday by its closest competitor Rent-A-Center (RCII), which reported fairly weak earnings, but whose guidance shook the market. Rent-A-Center’s lowered guidance is a result of the current financial distress, according to its Chairman and CEO, who said, “While we believe the economic environment creates opportunities for potential customers whose available credit is diminished or eliminated, it is creating challenges for our existing customers.” The company also took a serious hit from the impact of hurricanes Gustav and Ike.

Rent-A-Center was the company that predicted a rocky immediate future, but Ockham senses opportunity in the stock of its closest competitor, Aaron Rents. Up until about a month ago, RNT was one of the market’s star performers—up more than 50% for the first three quarters of the year. However, during the market’s brutal month of October, the stock has lost 45% of that gain. It seems to me that the market liked the way Aaron Rents was positioned to take advantage of cash strapped consumers up until recent market action virtually eliminated positive annual returns for all stocks. Most analysts are expecting a rough Christmas season for the retail sector, but rent-to-own companies have the look and feel of a retail operation while really being a hedge against it. When their washing machine breaks, are struggling consumers more likely to rent than buy outright at present?

Industry magazine RTOHQ published a good article Monday about the increased interest financial analysts have had in these stocks based on current economic turmoil. From the article,

“{Richard} May described industry trends and pricing structure changes over the last five years — such as 90-days same as cash and 12-to-own — are helping to expand the traditional RTO customer base.
“That has definitely attracted that more financially stable monthly customer,” Mays says. “In the past, our demographic has been narrowly defined. What we’re seeing today is dealers really reaching out to new customers through innovative pricing and marketing.”
As consumer credit remains scarce, customers as well as investors are giving rent-to-own a second look as an alternative financing mechanism for acquiring products May says.
“And that’s exactly what we want,” he says. “Now that the price of gas is back down, the dynamics of this economy are definitely in our favor.”

As for Aaron’s valuation, we believe that the recent selloff has definitely increased the attractiveness of shares. We have it rated as “Undervalued” but we will likely upgrade to “Greatly Undervalued” to take into account the 16% decline that the stock has experienced since our ratings were updated after last Friday’s close. Both price-to-sales and price-to-cash flow are well below their historical averages over the last ten years. So, we see a company that might be able to increase its business from consumers seeking out credit opportunities they might not have needed in years past. Although the company may experience more defaults than normal, the increased business is more valuable in the long run. For another idea in this space, check out Rentrak Corp (RENT); this stock is “Undervalued” as well but has not been materially affected by the market’s reaction to RCII.

Comments

[bearcasenyc:]

After listening to the RNT and RCII earnings call I am very surprised
from the the divergence in stock price performance. Excluding
furniture manufacturing for RNT and payday lending for RCII, these two
businesses are quite similar.

RCII stated they are experiencing customer count declines (even though
some higher income consumers are trading down) and projecting flat
same-store-sales ("SSS") for 2009 (I actually think they know there
will be SSS declines in 2009 b/c they are over-forecasting the price
of gasoline in their model). Additionally, they are experiencing
items rented per customer declining (1.59 units to 1.50 units) and
average rental price down $1. Charge-offs have also picked up. The
stock has traded down significantly as a result.

RNT is saying that they are experiencing customer increases and pick-
ups in SSS. Mgmt said for company owned stores, they experienced SSS
up 5.7% for stores open more than 15 months and SSS up for stores open
more than 24 months. Why is there such variability between store
ages? Also, franchisee SSS are up more than 18% - how is that
possible to have such a divergence from company owned stores and the
broader retail market? Mgmt said that average rental prices are down
8%, so to hit these high SSS they must have experienced a massive
increase in customer count. On the last call when asked what the same
store customer count was, Robin Loudermilk quickly said that he didn't
have that data available, even though Charlie said that is a metric he
looks at every day. Robin and the CFO were very quick to rattle off a
number of other very positive stats through out the call, however.
RNT is forecasting 2009 EPS of $1.65 to $1.80 - a pick-up to 2008. I
am really not sure what is going on here, but my feeling is that they
are engaging in some fuzzy accounting and hiding real performance with
asset sales and purchases. Their franchisee lender, SunTrust,
increased the guarantee requirement from 50% of the loan to 100% of
the loan, which would imply that they are seeing some issues with the
business. The Loudermilks have been selling shares (~450k this year)
regularly in 2008, too.

If someone can explain how the store operating metrics for Q3 and
expectations for 2009 can be so different I would be all ears. At the
end of the day, I think that RNT is trying to obscure actual
performance results for long enough for the economy to strengthen. I
think that if the economy doesn't turn by 2Q-09 the "lipstick on the
pig" will be washed clean.

2008 Nov 03 12:35 AM