Aaron's Company, Inc. (NYSE:AAN) is a leading provider of lease-to-own and purchase solutions for furniture, appliances, consumer electronics, and accessories. With the main focus on overlooked and underserved customers, the company provides services to less credit-worthy customers through its more than 1300 stores and an e-commerce platform. Also, with a focus on customer satisfaction, the company offers competitive monthly payments, high approval rates, and lease plan flexibility.
Aaron's provides the customer an option to acquire ownership of the merchandise over a renewable LTO plan, of about 12 to 24 months, by making weekly, semi-monthly, and monthly lease payments; customers also get the option to cancel the lease transactions at any time.
Also, With the consistent growth and market share gain, the company has become a market leader in the LTO marketplace, expanding its footprints through consistent growth and strategic acquisition.
In October 2020, Aaron's Company Inc. separated from Aaron's holding company and subsequently converted into a limited liability company; upon completion of the separation, the company changed its name to Aaron's Company Inc.
Furthermore, last year Aaron's acquired BrandsMart, one of the leading electronics and appliance retailers, with ten stores and a growing e-commerce platform. Management believes that the acquisition will strengthen the company's operations and provide customers with affordable lease-to-own and purchase options.
Currently, due to the adverse economic conditions the company has been facing reduced demands for the products, also high inflation is unfavorably impacting the customers' ability to make lease payments, resulting in higher merchandise write-offs, increased loss provisions, and customer delinquencies. which has affected overall profitability.
The stock has dropped more than 71% from its all-time high and is trading at a substantially cheap valuation.
In my view, the business model is substantially strong and unique, and as the situation normalizes, the company could regain its earnings power; and in such case, the stock will likely not remain undervalued at this price; the stock provides a substantial margin of safety and a huge upside potential in my view, so I think Aaron's is a buy.
In 2020, the company separated from its parent company Aaron's holding, and formed a limited liability company under the name Aaron's Company Inc.
I believe understanding historical performance is essential for understanding business economics, therefore to access the historical performance of the company, the investor must understand the historical performance of Aaron's holding inc.
Aaron's holding had been significantly profitable and, with time, has grown substantially, creating huge returns for the shareholders.
Also, it should be noted that the company had grown without major CAPEX and fund infusions, which shows that the business model is substantially strong and has been generating a significant amount of cash. Also, capital allocation decisions taken by the management were very much shareholder friendly.
Over time management invested the generated money in share buybacks and managed to grow its operations without significant CAPEX, which led to substantial value creation.
Over the period, profitability was volatile, but the overall returns were handsome.
The company's ability to produce significant cash flows is the primary reason for such phenomenal growth. The company has managed its working capital very efficiently, leading to a huge generation of cash flows.
Furthermore, during the recession of 2008, the business was performing very well and in fact, expanded its business reach significantly. It is because due to the economic crash, customers didn't have any credit facilities; therefore, even the high credit score customers were turning toward lease to own providers, and as we can see the company took very much advantage of such an opportunity and expanded its operations significantly.
By looking at the history, it seems to me that the business model is very much recession-proof and works strongly during the recession, but the current picture seems very much different, as the economic conditions are becoming worse along with the high cost of borrowing, the company's margins are facing a very different backdrop, with significant customer returns and increasing default loss reserves. In such conditions, customers are not able to pay the lease payments.
But the historical performance of this lease-to-own model was significantly strong, and can resist the current economic crisis in my opinion.
Aaron's has a unique business model, which provides the company with an edge over its competitors.
The company's more than 89% of total revenue comes from its LTO transactions. These renewable lease revenue streams help the business insulate itself in macro-economic disruptions, reducing reliance on the current period sales and customer traffic for its cash flow generation compared to other retailers.
Also, the business model provides the customer an opportunity to lease the product as long as they want and acquire them whenever they want, such an operation gives an edge to the business and also provides very much flexibility to the customer. Also, due to its lease operations, the company could provide the customer with a very competitive price, which drives customer traffic and repeat purchases.
Furthermore, over the period, the company has generated a very strong brand value and has attained a very high position, which is likely the reason why over the very long-term the company could maintain its profit margins despite a substantial increase in competition in the retail segment.
The investor must look at the store counts, it seems that in the last few years, total company-owned store counts, along with leased stores, have reduced significantly, but on the other hand, we can see huge revenue growth; it seems that the revenue growth is coming due the industry tailwind and e-commerce boom in the last two years, and if this is the truth then we might see a substantial reduction in the revenue going ahead. As the management states, in the last few years, the company has not entered into lease contracts but wants to make new contracts, also franchise count has dropped significantly, and it looks like franchises might be facing some trouble with the business.
Also, the current increase in customer delinquencies might persist longer than expected, and in such cases, the company will have to bear huge losses, which will affect the company's financial position.
Furthermore, the recent acquisition of BrandsMart might bring huge operating expenses, and if you look at its financial performance in this quarter, it seems that the business is growing at a reasonable rate. But my major concern is, to expand its reach, the business will require consuming huge sums of money which will further reduce the overall profitability, also note that its margins are substantially lower than the core business and hence we might not see any considerable returns from the BrandsMart operations in the next few quarters.
In the last quarter, due to adverse general market conditions, the revenue of Aaron's business declined, with a substantial hit to its EBITDA margins, but performed very well compared to its peers.
Due to the current increase in write-offs and adverse economic conditions, the stock has dropped more than 72% from its high in 2021, despite the strong and growing business model, the current market capitalization of the company is around $308 million, whereas it has produced more than $100 million in net profit and over $136 million in CFO the last year, also note that the company has produced significant and consistent cash flows historically.
Considering that the company is trading at just three times its 2021 earnings, and even if the company's earnings will lie around $50 million, the company is substantially undervalued and trading at just 6 times its low expected earnings.
I believe the stock has become substantially undervalued and provides huge upside potential, so I think Aaron's is a buy.
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