The Aaron's: Is The Company Cheap Enough For A Market Leader?

Summary

• The lease-to-own model has seen significant increase in interest and expansion in business over the past few years. Aaron's is the US market leader in the segment.
• A reader requested that I take a closer look at the business to determine whether it has an upside, as it has been trading "down" for some time.
• My stance on Aaron's is cautious - I consider the company's business model risky, and the company lacks the history to justify conviction here.
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Dear readers/followers,

In this article, we're going to be taking a first look at Aaron's (NYSE:AAN), a market-leading player in the field of leasing (lease-to-own) as well as retail purchase solutions in the theoretically attractive fields of furniture, electronics, appliances, and other home goods. This is a growing market, and though we haven't seen the sort of breakthrough for the business model in other areas in the world (such as where I live), the sector nonetheless has appeal in the geographies where Aaron operates.

The company isn't new - it was founded all the way back in 1955 and is headquartered in Atlanta, Georgia. The company, in its current iteration and split, has a market capitalization of less than a billion dollars - $450M to be exact.

So, let's break down what we're buying/investing in, and why it's a good idea to do so.

Aaron's - What the company is & does

So, the first thing you want to know is that Aaron's has been through a number of corporate changes over the past 20 years. In 2008, the company sold its corporate furnishing to CORT Businesses services, a part of Berkshire (BRK.B). The company further split its operations only 2 years back in 2020, when it split into PROG Holdings (PRG) and Aarons. PROG, or progressive leasing, is the fintech holding company with segments in progressive leasing, Vive Financial, and ancillary segments. Aaron's meanwhile retains the 1,034 and 234 company and franchised stores found in 47 states and Canada.

AAN IR (AAN IR)

So, the company focuses on leasing, or LTO of these aforementioned products. The core arguments for using AAN for the customers lies in excellent customer service, good value, competitive monthly payments as opposed to large one-time payment, good cost of ownership, good approval rates and flexibility on the leasing.

The company naturally also provides hassle-free delivery options, setups, services, and returns, and the ability to pause and resume leasing without any penalty to the customer - this is part of what sets AAN apart from other LTO companies I've looked at, reviewed, and worked with.

AAN IR (AAN IR)

The big news for 2022 is the BrandsMart acquisitions. On February 23, 2022, the Company entered into a definitive agreement to acquire 100% ownership of Interbond Corporation of America, doing business as BrandsMart U.S.A. This was one of the company's competitors in certain fields and had a history going back to 1977, bought in this case for $230M in cash.

Since it's 2022 business change, the company is working from a strategic plan that involves:

• Deliver efficiency in the company's store footprint in relation to customer opportunities. This is done with the GenNext store concept, which features larger store rooms, refined operating considerations, and a streamlined customer process. Increasing the use of tech, so to speak, as many companies are doing.

AAN IR (AAN IR)

• Simplify the customer experience, promotion through increased marketing with more attractive omnichannel marketing, including a technology-driven sales program.

In short, the company is seeking to use more digital tools, leverage those digital tools, and really present what the company offers in terms of wares in a very appealing way. Part of the company's argument for investing is exactly that it's not just online-based, but that the company has a whole host of attractively-presented stores, and that the selection and its portfolio have made it a recognized, nationwide leader in LTO.

This is evidenced by a repeat customer rate of 67% for new leases, which is very impressive. The company also allows franchising, and together with the franchise stores, the company had about 1.1M customers with active leases, which once again is very impressive.

The company also owns distribution - 2,300 trucks located throughout the network means that the company can fulfill most orders themselves, in the form of last-mile and reverse-logistical capacities in most markets. All Aaron’s stores have a dedicated logistics team and infrastructure that enable the company to offer our customers complimentary, prompt delivery, in-home set-up, product repair, or replacement services. The stores also offer refurbishment services, allowing AAN to provide pre-leased products for lease or sales and maximize inventory turnaround.

Furthermore, the company offers in-house upholstered furniture and manufacturing of bedding - through which they can produce no less than 1.5M units per year with its 800k sqft of manufacturing capacity - five furniture and six mattress locations. This gives the company quality and product control, as well as some risks associated with its own manufacturing.

The company has its operations in only one operating segment. The typical lease structure for a standard LTO is a 12-24 leasing option, with the payment options of weekly, semi-monthly, or monthly lease renewal payments. The customer can also bring the product back at any time, with no penalty, except for paying the accrued leasing period and any damages to the product that may have been incurred.

The fact that the company's services are also available to credit-challenged customers means that it's not just customers in need of temporary merchandise or trying a product at home that are likely to want the company's services, and the repeat customer behavior mostly cements this positive thesis/case.

The company does not have a credit rating worth mentioning, but it does yield around 3%, and that payout is well-covered with an adjusted EPS payout ratio of less than 40%.

From a high level, the company is attractive. What I mean is that AAN manages a 58-63% gross margin, going down to around 7.5-12.5% operating margins, and a net margin of around 4-6% to the bottom line. It's not the best I've seen, but for the business that AAN is in, it's attractive. The company does have debt, but it's not worryingly high at just about 50% debt/cap.

AAN is unlikely to be a significant grower going forward. While GAAP will likely increase, the average estimated annual EPS growth rate is around negative 1.35% at this time - though this also includes the impact from the 2022E fiscal, which is set to come in around 40%+ lower than YoY, and for 2023 to be negative as well.

3Q22 results are the latest results we have for AAN. The company keeps chipping away at its debt, reducing it by around $46M in 3Q22. Top-line growth is good.

AAN IR (AAN IR)

AAN is relatively undercovered on SA - though not as much as some companies. This is a business model that has proven resilient not through one, not two, but many, many economic downturns. The company's approach is logical. What needs looking into is not allowing the operation of unprofitable stores. Unfortunately, we do not have unit-level numbers, so we need to trust the company to be able and motivated to close unprofitable operations and manage its portfolio efficiently. The recent history of the company has seen significant declines, and this has to do with impairments and write-offs, as well as macro conditions.

Remember, AAN at one point traded close to $35/share. It's no longer close to $10, but we're barely at $15 here.

Let's look at what we have in terms of Aaron's valuation.

The Aaron's Company - Valuation

So, the valuation for this company isn't as positive or as stable as the most recent articles may suggest. First things first - peers and competitors - Aaron's has none. You could argue the bedding and mattress business competes with businesses like Leggett & Platt (LEG), but this would be a stretch given the mix and volume of that business and the way they operate. So peers are a no-go here. Because of the differences in sectors, you can't really argue that other companies in ancillary sectors that lease completely different products are competitors either.

However, we do have analysts and forecasts. As I mentioned, based on the current set of market forecasts, the company is essentially slated to be about flat for the next few years. This is also reflected in a very conservative set of analyst price targets for AAN.

6 analysts follow the company. Out of those, we start at a low PT of $6.5 and go up to around $20 on the high end. The average from these analysts comes to around $13.92, which is below the current price of $14.9, and implies an overvaluation of around 6.5%. 2 out of those 6 analysts are currently at a "BUY" rating, with the rest at "HOLD" or Underperform ratings.

Now, tendentially, I would agree with this. The reason is that based on a normalized P/E ratio for the past few years, the company usually trades at a range of 6-8x P/E. For that range, the company's forecast implies trivial and market-underperforming RoR at less than 4% annually to around 6.5x.

AAN Upside (F.A.S.T Graphs)

The fact that the company has positively outperformed analyst forecasts doesn't really matter - there's too little data for this to be relevant enough to include it in the calculation for the company, as I see it. While it's entirely possible that the company will deliver growth after 2022-2023E, I don't see it happening prior to that, and this complicates things. The reason is that there are plenty of investments with substantially better upsides and fundamentals than AAN out there.

If we were looking at trough valuations of below $10/share, I could see my way to allowing for a speculative "BUY" rating here, based on an underappreciated and time-tested company with a very good upside. As it stands now though, this is very far from the case. Normalized P/E's are up at 11x, with a 7x EBITDA multiples. I have investment-grade businesses that don't trade at those multiples - and those are with far better histories.

The positives that can be mentioned are sales and revenue multiples - from those perspectives, the company is being treated almost with disdain by the market, allowing only for a 0.19x sales multiple. Now granted, the company's sales are some of the "least sticky" out there given its hassle-free return policy of LTO assets, but the repeat customer rate should push this somewhat higher.

In terms of sales, the company is being treated like dirt.

AAN Sales (TIKR.com)

Even the latest recovery is only slightly visible here, and at times, as you can see, the company was at staggering 0.11x sales, which is some of the lowest I've ever seen.

Lack of predictability and data makes DCF mostly useless in Aaron's - what DCF I do calculate and use implies a fair value of less than $7/share - but again, this is uncertain due to how the variables are used here. I could shift around discount rates, but I refuse to use a lower discount rate than 9.5% at today's market conditions.

So, for now, I'm agreeing with the consensus - Aaron's is not a "BUY".

I would give the company a PT of $10/share. This comes to a 3-year normalized P/E of 6.5x, which is also where the company has usually traded.

This is my thesis for the company as it currently stands.

Thesis

• Aaron's is a company with a very attractive business model, but very little current data following the split and recent merger. Because it has a market cap of less than $500M and no credit rating, it goes into the relatively risky category regardless. Still, it's a storied business with decades worth of tradition.
• I would consider the company attractive at multi-year low or conservative multiples, around a 6.5x P/E, or a $10/share price target, which is significantly below the $14.9 we're at today.
• Because of this, I would view AAN to be a "HOLD" here.

Remember, I'm all about:

1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.

2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.

3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.

4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them (italicized).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside based on earnings growth or multiple expansion/reversion.

This company lacks the valuation-specific upside I look for in my investments - I say "HOLD".

Analyst’s Disclosure: I/we have a beneficial long position in the shares of LEG either through stock ownership, options, or other derivatives. 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.

While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. Short-term trading, options trading/investment, and futures trading are potentially extremely risky investment styles. They generally are not appropriate for someone with limited capital, limited investment experience, or a lack of understanding for the necessary risk tolerance involved. The author's intent is never to give personalized financial advice, and publications are to be viewed as research and company interest pieces. The author owns the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in the articles. The author owns the Canadian tickers of all Canadian stocks written about.