Conn’s (CONN): A retailer and subprime lender with 79 retail stores selling mattresses, appliances and electronics. It operates in low-income areas where it offers financing for overpriced products at high rates. This short is crowded but is still a good idea. Market Cap $1.5B.
- Its recent growth has all come from extending more credit and loosening credit standards.
- When valuing the subprime credit and retail businesses separately as opposed to viewing CONN as a growth retailer, a sub $30 value is more appropriate.
- It is unclear how well CONN will mange the increased credit risk. Large losses could occur in the accounts receivable (AR) portfolio.
1. The AR portfolio was $1.07B on Jan. 31, 2014, up 44.1% from the prior year. Average account balances are up over 28% in the last two years, while credit scores and down payments have dropped. CONN has posted positive net income for two straight years after two years of losses, but at the same time cash flow from operations (CFO) has been negative in the last two years. This growth is unsustainable as CONN had CFO losses of ($210M) last year and has only $295M of available debt under its credit facility and minimal cash.
2. The company should be viewed as a retailer and subprime lender by the market. When applying separate valuations for these two businesses, a price below $30 would make more sense. Income before taxes from the credit segment slipped from $28.5M to $12.5M in the most recent year. With bad debt increasing in the most recent quarter, the credit segment had a ($6.5M) loss. The decline in quality of the credit segment and lower multiple associated with subprime lending should bring the valuation down.
3. Bad debt expense will certainly go up, but it is unclear how much this problem will be compounded by repeat customers and growing debt burdens per customer. ~60% of payments are made at store locations, which could pose additional credit problems when closing stores.
Next Steps: I plan to research the AR portfolio and lending standards. There is an advantage to be gained by understanding the quality of the AR portfolio better than Wall Street.
Potential Catalysts: Missing guidance as bad debt piles up and growth slows. As problem loans are given time to surface, the street will have more reason to value the two businesses separately, creating multiple compression.