Conn's: Where'sThe Cash Flow?

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

Conn's (NASDAQ:CONN) is 70 store chain based in Woodland, Texas that generates just shy of $1 billion of revenue annually. The company leverages a full time, commissioned sales force and a variety of financing options to sell a mix of appliances, furniture, and consumer electronics items.

The company's stock has been on a hot streak of late, increasing over 230% since last June. Conn's posted rather eye-popping topline and margin results in the latest fiscal year:

  • Same Store Sales increased 2380 bps vs. two years ago, from (9.6) percent to 14.2 percent
  • Retail Gross Margin increased 870 bps vs. two years ago, from 26.5 percent to 35.2 percent.

The results have largely been driven by Conn's focus on the furniture/mattress category and expansion of its flexible financing value prop.

Shifting Assortment to Furniture and Mattresses

Conn's increased its assortment and selling space dedicated to higher margin furniture and mattress products over the last few years. The effort manifests in sales mix results with furniture and mattresses accounting for 23.5% of sales in FY14Q1, up from 17% of sales just a year ago. The category delivered a gross margin rate of 48.3% (vs. 33.5% for Appliances) in the same quarter.

Not only does this category help increase average selling price and margins, but also (according to Conn's) provides a hedge against showrooming. The company further claims that this category is complimentary to its 'credit and distribution model.'

Pushing Credit

Conn's goal with its flexible financing value prop is to help 'below average income customers purchase 'above-average, branded products.' The additional focus on credit shows up in the overall percent of sales financed, with 89.6% of its sales financed in FY14Q1, up from 83.1% last year and 64.8% two years ago.

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*Conn's Data

As of last quarter, 68% of its customer base had FICO scores between 550 and 650 versus 20% of the national population having credit scores in that range.

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*From Conn's presentation

Conn's claims that its credit offerings help otherwise cash strapped customers step into more "aspirational" purchases, thus driving oversized average selling prices. For example, Conn's says its average TV selling price is $1,013 vs. a market average selling price of $451.

Financials Results: Income Statement Looking Good, but Where is the Cash Flow?

Conn's financing and assortment initiatives have grown topline and margin rates, thereby driving EBITDA growth.

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*Public financial data

Unfortunately, EBITDA growth has not translated into cash flow, which has declined since mid 2011.

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*Public financial data

So why isn't Conn's turning EBITDA performance into cash flow growth? Part of the reason is that Conn's has increased the pace of capital expenditures for new store openings, but that only explains the difference between operating and free cash flow.

Another reason could come from the increased mix of sales being financed. The more sales financed, the more time it takes to collect cash and more risk is placed on future cash flows.

As shown below, Conn's cash conversion cycle has trended upward while cash flow has declined.

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*Public financial data

In addition, Conn's cash conversion is 3x to 4x that of the two competitors depicted below. Granted, these competitors don't finance nearly the mix of sales that Conn's does.

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*Public financial data

EBITDA, not Cash Flow, Is King … To This Point

A simple correlation analysis reveals that Conn's stock price has followed EBITDA growth in favor of cash flow trends. In fact, the stock price has a slight negative correlation to free cash flow.

For those who subscribe to cash flow being the best predictor of long term stock price, this could be cause for alarm over the long horizon and could warrant some attention.

Looking ahead, the favorable income statement metrics are a good sign that Conn's initiatives are resonating with customers, but I'm staying on the sidelines until the company proves it can turn that success into cash flow.

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.

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