Conn's: Don't Celebrate Just Yet

| About: Conn's, Inc. (CONN)


The market is responding well to Conn's quarterly and end-of-year report, but might be missing a bigger underlying problem.

Conn's reliance on credit is becoming more evident.

Overall, Conn's gains could be short-lived, as the growth of its credit program backfires.

Conn's (NASDAQ:CONN) investors like what they heard on the company's earnings report and conference call, as the stock is currently trading higher by 12%. And while the company's total revenue growth of 38% in fiscal year 2014 is impressive relative to Best Buy (NYSE:BBY) and Aaron's (NYSE:AAN), there are still plenty of reasons to believe that this rally will be short-lived.

A little history of Conn's

Conn's is a specialty retailer of durable consumer products, selling things like mattresses, TVs, and appliances. Essentially, it is a smaller Best Buy, with annual revenue of $1.19 billion in the last year. However, the one key difference is its growth, 38% last year, driven by a 26.5% increase in same-store sales.

It was this growth that sparked a 165% stock gain in 2013. However, it was the cause of this growth - its credit program - that has created a 50% decline in 2014. Essentially, Conn's in-house credit program began to see higher delinquent loans, which consequently affected the company's bottom line profits.

However, with booming same-store sales growth and a 370 basis point increase in gross margin, investors are looking past this underlying problem, or at least temporarily.

Where is the growth coming from?

There is a belief among some Conn's investors that the company's credit business is not a big deal, or not essential to the company's growth and future. This reasoning can be explained with the company's revenue, as some might note that of Conn's $361.1 million in Q4 sales, only $27.8 million was created from its credit segment.

While this is true, the problem with Conn's is the large sum of debt that created that $27.8 million, and the rate at which it continues to grow.

One thing you might have missed in the company's quarterly report is that Conn's customer portfolio balance, which is its credit division, was $1.07 billion on January 31. This equates to a rise of 44% over last year, or a $326.7 million increase. However, if we look at Conn's revenue, it saw a $277.6 million increase in fiscal 2014 over the year prior.

So, what does this tell us? Essentially, this shows that all of Conn's enormous and impressive 38% same-store sales and 26.5% total revenue growth is coming from its credit program, or borrowed money. It also means that existing customers, or those who might have paid with cash in the past, are now using credit; or possibly, it means that Conn's is losing a lot of money to this program. In fact, this disconnect between credit and revenue growth might tell us that all three statements are true.

With that said, so long as customers are paying their bills and Conn's is collecting fees, then everything is great. However, Conn's is not lending to the safest of consumers. In fact, its average weighted credit score is just 594, according to its end-of-year report, which helps explain the company's sudden profit warning earlier this year.

Final Thoughts

In the end, Conn's continued and rising reliance on credit for growth will most likely lead to more abrupt profit warnings, and could even bankrupt the company if all hell breaks loose, such as another credit crisis. Already, in the infancy of this program, account balances 60 days or more past due have risen 78% year-over-year to 94,403, a far greater rate than revenue growth.

Also, this represents 8.8% of its total account balance, which is up from 8.5% in October and from 7.1% last year. Clearly, the trend is not in Conn's favor, and with the balance itself rising so rapidly, Conn's is becoming more vulnerable by the day. As a result, I would not chase these large, double-digit post-earning gains, as more than likely, this story will end with Conn's crashing down!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.