Aaron's Vs. Rent-A-Center: Whom To Own In Rent-To-Own

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Includes: AAN, RCII
by: Michael Boyd

Summary

Rent-to-own operates best in low growth periods for the economy.

Aaron's and Rent-A-Center control half the market but attract different types of investors.

The rent-to-own business is a stable market based on American consumerism – the business model isn't going anywhere anytime soon.

Aaron's (NYSE:AAN) and Rent-A-Center (NASDAQ:RCII) operate in a consistent but uninspiring business. They both lease goods such as appliances, computers, furniture, and other accessories under rental agreements to customers. Both companies operate thousands of stores in North America with most operated right here in the United States. It may not be the most glamorous model, but it consistently produces solid revenue and profit. Consumption is at the heart of the American consumer - in good times and bad, we aspire to own the newest and greatest products. And frequently many US consumers are willing to forgo future purchasing power for immediate gratification which is where these businesses come into play.

Rent-to-own is an interesting business that operates best in low growth periods for the economy. Too strong of an economy and more consumers will simply buy their desired items rather than going through rental agreements. Too weak of an economy and more consumers will simply forgo consumption because they can not afford even the proposed payments.

Current Valuation Metrics

Margins are similar between the two companies. Aaron's appears much more efficient at controlling operating expenses.

Of note is Aaron's is down significantly since the highs it made in June prior to Q2 earnings release on the heels of takeover speculation (the offer rejected was $30.50/share - lower than what it trades at today). It currently trades at a premium to RCII on price/sales and price/book values, which seems to be predicated upon expected growth 2016 and later, which we will discuss further on.

Earnings History and the Future

Both companies over the past year have consistently met earnings estimates set by the Street. The weak quarter here is obviously RCII's troubling ending to 2013, which was predicated by both one-time items ($0.08/share for increased costs in their self-insurance program, $0.03/share severance impact, $0.10/share in merchandise reserves, and $0.04/share due to nondeductible goodwill impact on taxes due to rebranding) and unexpected margin contraction (EBITDA margin declined 4.7% to 8.2%).

Which brings us to future growth. While forecasts were made for a similar 2014 between the two major players in the space, the future looks much different. AAN is forecast to double the growth of the S&P500 over the next five years, while RCII's projections are rather anemic at 3%.

We Can't Forget the Dividends...

RCII does pay a good dividend, but it is important to note that they do not have a lot of cash on hand and their current ratio is not great either, so short term debt is a concern. I do not think RCII will cut their dividend, and they haven't since they began issuing it, but if you are looking for yield as an income investor there are far better companies with safer balance sheets at this yield.

Summary

While both operate on the same industry, they attract different types of investors. AAN is geared toward good growth in the next five years and actually makes for an safe, attractive option for a growth investor with its low beta. The potential for an acquisition remains. RCII is more attractive to income investors because of the dividend.

Personally to me, AAN is the more compelling buy. RCII's future seems more bleak at present and investors looking for income have more attractive options elsewhere. The argument could also be made for a hedge bet here - long AAN, short RCII for a market neutral strategy.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.