Aaron's: Doing Well And Positioned For Continued Growth

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About: Aaron's, Inc. (AAN)
by: Andrew Sather
Summary

Aaron's latest project with a non-profit demonstrates their commitment to the 3 ways the company plans to increase long-term value.

The track record of Aaron's reflects a management that is being efficiently run on all cylinders (earnings, dividend growth, and acquisitions history).

This company reminds me of a young Walmart. This article explains why.

Aaron's (AAN) stock has had a strong 3 years with great business growth and fundamentals. This is a stock I'm continuing to hold, as I believe this is a trend that will continue. Not only are the financials behind Aaron's great, but so are the intangibles and the way that they run the business, as this article will discuss. Past performance is never a guaranteed indicator of success, but the company is showing signs that its growth should continue to compound capital for long-term shareholders like myself.

On May 31st, 2019, Aaron's announced the completion of a renovation for a new Boys and Girls club in the same city the company is headquartered in, Atlanta, GA. In partnership with Sherwin-Williams (NYSE:SHW), the company provided fresh furniture and paint for the non-profit BGCA (Boys and Girls Club of America), helping to propel young teenage boys and girls with the skills to succeed in the business community.

While there's no financial result for current and prospective investors to evaluate from this event, it does provide a yardstick to measuring how the company is stacking up in its 3 stated commitments for increasing the long-term value of Aaron's business:

  1. Enhancing Aaron’s omni-channel platform to drive revenue and operate more efficiently
  2. Investing in customer-facing programs to support growth
  3. Remaining opportunistic regarding acquisitions

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In particular, this BGCA makeover - along with its other 37 makeovers in the past 5 years across the country - demonstrates an apparent investment with customer-facing programs.

Perhaps the most telling part of these types of events is in how it aligns with the company's mission, partnering with the community for profitability rather than taking an adversarial approach. Unlike other rent-to-own companies, Aaron's doesn't require a consumer's credit report. Instead, the company relies on a combination of income verification, resident information, and personal references. Considering that an inquiry on a credit report could ding an already poor score, this alternative measure of trustworthiness embodies much of what Aaron's seems to represent: an opportunity for second chances and the possibility for atoning for previous mistakes. It seems to come with an element of human understanding, in an industry that is mostly hated by the finance community for being crooks and thieves of the less fortunate.

Is the company remaining opportunistic regarding acquisitions?

This is perhaps an even more subjective evaluation than the previous one. Where at least the answer to whether the company is investing in customer-facing programs is something that can be either seen or not, you could argue that the word opportunistic could define an emotional thought rather than an observable yes-or-no, fact-or-not.

What we can examine is the acquisition history of Aaron's. The two most recent acquisitions involved acquiring SEI/Aaron's Inc. in 2017 for $140 million (all-cash), and acquiring Progressive Finance Holdings LLC in 2014 for $700 million (again an all-cash transaction). While past performance is never a guarantee for future results, I think it's safe to say that the company has a preference for all-cash acquisitions, and the way that they sustain their balance sheet confirms a conservative financing strategy (current long term Debt to Equity = 0.23).

Today, the Cash-to-Debt profile (taken from Gurufocus) for AAN is lower than it's been in recent history, and is slightly below where most of their competition lies right now.

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From a Price to Cash perspective, the stock is neither overly gushing with cash nor lacking cash (Price to Cash = 28.86). This neither confirms nor denies an "opportunistic" take on the acquisition strategy. It wouldn't be fair to condemn the stock for an acquisition they didn't (or will never) make, and so it's not fair to say that the company isn't carrying enough cash unless we can definitively say that an acquisition target out there was an opportunity missed because of lack of cash. Let's not betray the "innocent until proven guilty principle," because as of now, the company's previous two acquisitions have seemed to be value accretive rather than value destructive. With the stock's strong financial performance the past several years, I'd say management seems to be in-line with their "opportunistic" acquisition strategy.

Growth Potential: Comparatively Very High With A Possibility Of Tripling

When I think of a business model like Aaron's, I can't help but compare it to a retailing empire like Walmart (WMT). According to Numerator, the demographics for the types of customers who shop at Walmart tend to tilt on the lower income side:

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Aaron's reports of a similar tilting in customer demographic but from a credit score perspective:

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Of course, both companies are also retailers who feature massive selections in their big box stores, with profit margins that are generally lower than competitors. What I find even more fascinating, and perhaps indicative of the growth potential for Aaron's, is the similarities in the characteristics of their stocks - except it just seems like Aaron's today is the same as what Walmart was 30 years ago.

Many investors know that an investment in Walmart over the last 30 years would've been a fantastic investment, and most investors today see Walmart as a perfect sort of dividend growth investing (DGI) story. What many might not know is that the company didn't appear like the typical kind of dividend stock that most DGI investors target today. Back in 1987, Walmart's market capitalization was $21.66 billion, and today it's almost $300 billion. But finding a pot of gold like WMT back then wasn't finding picture perfect stock characteristics, nor was it gambling on a growth stock.

When I think of what DGI investors look for in a stock, I tend to envision its:

1. High dividend yield

2. Long track record of dividend growth

3. Good earnings growth track record

In the real world, it seems to be "pick 2" and never "here's all 3." Because of this, I feel that a stock like Walmart in 1987 wouldn't have been on many Dividend Growth Investors' radars, and yet it's ended up being the perfect DGI stock.

In 1987, WMT had 12 years of consecutive dividend increases but only had a 0.44% dividend yield. They did have a good track record for earnings both in the short and longer term, and like I mentioned, the market capitalization back then was only $21.66 billion. Compare this to AAN today.

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The company has 13 years of consecutive dividend increases and a forward yield of 0.26%, and the recent 5-year dividend growth rate of 11.66% implies a great earnings track record to go along with it. At a market capitalization of just around $3 billion, Aaron's is considered smaller cap compared to the rest of the S&P 500 - again similar to the case of Walmart in 1987.

Why I find this as a compelling case for Aaron's potential future growth is that currently Walmart has 11,766 global stores, with 4,769 of those being in the U.S. While Aaron's also has a wide reach with many stores across the U.S., their total number is just a fraction of Walmart's: 1,603 by my count using their store locator on the website.

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With that many stores and combined with their strong balance sheet and income statement, it's clear that Aaron's has a proven, working model for success. Yet the lower number of total stores open today suggests that more expansion is yet to happen domestically. As you can see in the map, there's no global expansion yet, which could push a growth catalyst that could expand far past the simple 3x figure that would represent a 3x increase in stores to match Walmart (from 1,603 to 4,769).

Now of course, the number of nationwide stores is just a starting point and by no means a concluding point on an analysis. A retailer like Aaron's could just as easily find catalysts of growth through the same-store sales rather than total number of stores, an expanded product line or new category of products to supply and sell, or other kinds of efficiencies (administratively, financially, or otherwise) that unlock greater profits. This would go directly in-line with the 1st point on Aaron's long-term plan, which would be to "enhance the omni-channel platform" to drive revenue. That remains to be seen.

But it all makes for an interesting thought experiment that Aaron's, which by the way earned $3.89B in revenue last year compared to its closest competitor Rent-A-Center, Inc. (RCII) at $1.28B, could still be in its infancy stages of its real growth story, and that the gains have just begun.

Potential Risks

The most obvious risk to slow this growth thesis would be an impending economic collapse or other major uncertainty among consumers. Aaron's is shielded from this somewhat, as their business model caters to individuals in financial need and provides an alternative to those who can't afford to purchase furniture outright.

However, this risk is always there and can't be ignored. While I believe the company's strong balance sheet would shield much of the impact of a temporary period of lower earnings, such a development would slow the expected growth and likely suppress share price levels. Maintaining a long-term position in the company mitigates this risk for the patient investor, but short-term pain would be expected with such an occurrence.

Looking Ahead

It's tough to make predictions about the future and how long it would take for this thesis to hold. If the company were to continue to produce exceptional operations, I'd expect continued growth in a similar trajectory to what we've seen, barring any unexpected risks. Valuations could expand from here were this to be the case, especially if the valuation of the overall market continues to rise. However, as some of the data above showed, investors today aren't buying into the stock at unreasonably high historical valuations, which could unlock share price growth in addition to the expected price increase from great business results. Only time will tell, but I'm continuing to remain optimistic and hold AAN for the long term.

Disclosure: I am/we are long AAN. 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.