We believe that Conn's Inc (CONN) is deeply undervalued by the market, which is completely overlooking record results that the company has recently achieved. The firm continues to grow its retail and credit platform with 8-10% growth expected going forward. Furthermore, the firm is a potential investment for a value investor as the firm trades at a very low P/E of 9.97. There is a good risk/reward at current levels.
CONN is continuing to grow and has achieved record results as a result. It seems that Wall Street is completely discounting this growth story though or believes it’s not sustainable. The firm just announced its best quarterly earnings in its 129-year history.
This is with earnings of $29.5 million and EPS of $0.91. 2019 adjusted EBITDA was a record $212.8 million, 27% higher than last year and 18% higher than their previous EBITDA record. This was driven by better same store sales, retail gross margins improving and bad debt charge offs improving in 2019, in comparison to previous years.
Furthermore, the focus going forward is on continued retail growth, accelerated store growth and positive same store sales. We believe that this will increase revenues and profits for the firm going forward. The firm projects that it will achieve 8 – 10% annual retail sales growth and as the CEO stated: "We believe we can continue to grow at this rate for many years to come and there’s a long-term opportunity to create sustainable shareholder growth." The firm has continued to move into new product categories that have achieved better than expected demand and led to increased revenue. In 2019 this includes gaming systems, robotic vacuums, new upholstery and dining collections. These new product categories we believe will help revenue to increase over the next few years. In 2020, the company is also expected to move into the cellphone and flooring products categories. The new products are in-line with the retail and credit strategy that the company has.
These new product categories have been positive for retail gross margins for the company. They increased 2.3% to a quarterly record of 42.4%. Annually this figure is 41.2%. This is the first time that the company has ever achieved a margin over 40% annually. We believe that the retail gross margin is sustainable, at the current pace that the company is going at.
In 2019 7 new stores will be opening in Texas, Virginia and Louisiana. In 2020 12-15 new stores are expected to open. This highlights the firms continued growth and success from its stores. It hasn't been decimated by the internet. The expansion to new stores will be positive for earnings growth moving forward.
Although the industry that CONN operates in has a low barrier to entry, the firm benefits from competitive advantages. These include, its wide range of financing options, in-house credit programs to credit-constrained customers, enhanced customer service, product repairs, next day delivery as well as its superior customer shopping experience from unique sales training and product knowledge.
The firm has competition from the following firms:
- national mass merchants - Walmart (NYSE:WMT), Target (NYSE:TGT), Sam’s Club, Sears (OTCPK:SHLDQ) and Costco (NASDAQ:COST)
- national retailers - Best Buy (NYSE:BBY), Ashley Furniture and Mattress Firm
- home improvement stores - Lowe’s (NYSE:LOW) and Home Depot (NYSE:HD)
- online - Amazon (NASDAQ:AMZN), Wayfair (NYSE:W) and manufacturer-direct websites
What none of them offer that CONN does is a solid credit offering. CONN offers its proprietary in-house credit program for credit-constrained consumers. This credit model has expanded in 2019. We believe that this continues to stand CONN out and gives it access to consumers that its competitors don't. The credit segment has continued to grow and has led to the firm reporting $5.7 million of revenue this year vs a loss of $26.4 million last year. This is a $32.1 million improvement in credit segment operating income, which was aided by an annual record net yield of 21.3%. This focus on the retail model and credit platform is what is expected to increase sales by 8%-10% yearly moving forward. We believe this is attainable by the firm, based on their focus and moves that they have made.
We also believe that selling items such as furniture and mattresses are a better experience in person than online, which has helped CONN. They are the sort of items you want to see in person and try. CONN itself has continued to emphasize its furniture and mattress offerings and is building larger stores to account for this. This should help the company against online competitors such as Amazon. CONN’s recent earnings show that the internet cannot completely stop their business.
CONN itself has embraced the e-commerce model. We believe this is positive going forward as e-commerce continues to grow in size. This allows CONN to build a huge platform around the niches that it focuses on and even provide competition to some of the most established firms like Amazon. Again, what stands CONN out on its e-commerce platform is the ability for consumers to buy an entire product with credit. Although we believe that a trillion-dollar company such as Amazon would have the ability to introduce this program if they wanted to. Amazon has previously shown its ready to do whatever is necessary to increase sales.
The total credit applications by CONN’s online are:
- 59,000 credit applications per month in 2019
- 57,000 applications per month in 2018
- 53,000 applications per month in 2017
We believe that there will be more competition online though as virtual reality and AR become more popular. They will allow consumers to see furniture in their house more readily and could lead to more online purchases. CONN will need to stay on top of these trends and offer them to consumers on their online platform. A failure to do this could lead to a loss of market share against online competitors.
CONN’s year end January 2019 was an EPS of $2.33. At the current price of $23.25 that gives the firm a very low P/E of 9.97. In the next 2 years, these estimates go up to $2.81 in 2020 and $3.25 in 2021. This highlights the growth projected at the firm over the next few years and makes the current P/E of just under 10 a bargain for a value investor. The Forward P/E is 8.27.
The industry that CONN is in has an average P/E ratio of 19.95. The P/E of the firm is ranked lower than 84.25% of 724 companies. CONN itself has an average P/E of 20.86 over the past 10 years.
The low multiple of 10 therefore makes no sense to us. The firm is trading at a discount to the overall market, its industry and its historical price. If the multiple of the firm was to trade at a more respectable P/E of 12 based on $2.81 earnings in 2020, we get a conservative valuation of $33.72. This presents upside of 45% from current levels, in the next 18 months. There are 6 sell side companies that cover CONN and every single one of them gives the company a strong buy rating, with an average price target of $36.5.
The future expansion anticipated by the company will be funded by future cash flow and revolving credit facility. Therefore, the company is reliant on healthy capital markets. If the company was to be assigned a bad credit rating, this would increase borrowing costs. The company is also reliant on its ability to meet debt covenants, the health of its earnings and the conditions of the financial markets in general. If the firm is unable to obtain adequate capital, then future growth or expansion plans would be curtailed. We believe this would hinder the firm’s ability to grow revenue. We don’t see the firm having a problem raising capital though. This is a company that is achieving record revenues and has established a solid brand over 127 years. The company will benefit from current low interest rates as well. We therefore see this risk as small.
CONN operates in a very competitive landscape. The businesses that they operate in have very low barriers to entry. The competition is from national, regional, local and internet retailers of furniture, mattresses, home appliances and consumer electronics. Some of their competitors have better financial resources and are able to purchase inventory at lower costs and withstand bad economic conditions better. If their competitors were to form strategic partnerships or consolidate they would be able to compete with the company better as well. A competitor with the right strategy, such as aggressive marketing, expansion by a new entrant or competitor into existing markets or a firm with a lower pricing strategy could take market share from CONN’s. CONN’s has its competitive advantages though such as having one of the most comprehensive credit programs out of any of their competitors. This gives them a competitive edge. This is along with the brand that the firm has built over 100 years.
The firm has a reliance on relationships with key suppliers and manufacturers in Asia and Mexico. To quantify this, 6 of CONN’s suppliers account for 65.3% of total inventory purchases for the company. If CONN was to lose one or more of these key suppliers, or fail to maintain a good relationship with them, it would severely disrupt their supply in the short term. They would also lose in the short term the competitive prices they had bargained with suppliers. Any unforeseen events in the Asia or Mexico such an environmental disaster or increased tariffs could be a problem as well. We are currently in the mist of the trade war intensifying between America and China and this has the potential to harm profits moving forward. Although we could argue that the risk is mitigated somewhat when you consider the fact that all of CONN’s competitors will face the same pressure, so it’s not just CONN being affected.
Southern Region Reliance
Most of CONN’s stores are located in the Southern region of the US, especially in Texas. 57 out of 148 of CONN’s stores are located in Texas. This makes the company exposed to regional risks in the South, such as the economy, weather conditions, possible hurricanes or other natural man-made disasters. If the South of the US was to have a downturn this would put pressure on future earnings. Some of CONN’s competition in comparison have exposure across the country so they don’t face the same level of risk to one region of the country. It would be ideal if CONN had a more diversified portfolio across the country. Although another way to look at it is that CONN has only penetrated a small amount of the US geographically. We believe that in line with their expansion strategy, CONN has the potential to open new stores across the country and further increase revenues.
It is surprising to see a company like CONN trade at such a low P/E multiple of just under 10, with the amount of growth projected for the company. We believe there is 45% upside in the stock from current levels, with the sell-side projecting 57%. CONN has a solid strategy in place to increase retail and credit sales, on top of recent record results. This will support earnings growth moving forward. Every value investor needs to take a serious look at CONN.
Disclosure: I/we 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.