Conn’s: Good Initiatives But Difficult Macros

Investment thesis

Conn’s (NASDAQ:CONN) stock has taken a severe beating, falling ~70% from the 52-week high price of $28. The company is facing significant macroeconomic headwinds. However, it is taking several steps like building an in-house lease-to-own platform and by experimenting with the store-within-a-store concept beginning in Q3 of this year. While these initiatives are interesting and the stock may benefit if they gain traction, I would like to wait for a couple of quarters to see the progress and impact of these initiatives on sales before becoming more positive. For now, I have a neutral rating on the stock given the challenging macroeconomic environment.

Macro woes

The difficult macro environment is impacting the company’s results as Conn’s laps difficult comps from the last year-end, and higher year-over-year supply chain costs, including fuel and freight.

Management is making adjustments in the business in order to navigate this more difficult operating environment over the near term but their outlook for the remainder of the fiscal year 2023 has now become more cautious. As a result, the company’s stock price has seen a sharp correction.

On a consolidated basis, the company’s total revenue in the first quarter was $339.8 million, which declined 6.6% from the same period last fiscal year, and missed a consensus estimate of $360.78 million. There was a 9.5% decline in the first quarter same-store sales due to the challenging macro environment, the lapping of government stimulus, and continued third-party lease-to-own tightening.

In-house lease-to-own platform

Conn’s Inc. reports its revenue under the two segments: Retail and Finance. The retail portion contributes close to 80% of the total revenue and the rest comes from the Finance charges and other revenue. Conn’s Finance business closely complements the retail segment. Conn’s provides various facilities of payment to its customers. In addition to payment through cash and credit cards, it also runs two major programs. One is “Conn’s HomePlus Financing” and the other is “lease to own programs”. Conn’s HomePlus Financing is a retail instalment contract or direct loan that allows its customers to borrow a specific amount and pay it back over a designated length of time.

The other program, an in-house lease to own platform, is where the management is putting most of the effort. Earlier this year management announced that in order to begin originating leases in-house, it has acquired a technology platform that will enable it to originate and service lease-to-own transactions in-house. In these transactions, the company purchases merchandise and lease back to its customers, charging them rental payments in accordance with the agreement. While the customer takes the merchandise home, it is the company that still owns the merchandise until the customer purchases it from Conn’s by exercising one of the two options: 1 the Early Buyout option; or 2 the Early Purchase option.

The company has set a target to achieve $2 billion to $2.2 billion in annual revenue and a high single-digit EBIT margin by the fiscal year 2025. Management is counting on this in-house lease program to add meaningful incremental revenue and profit to help the company’s 2025 targets. While management hasn’t given incremental revenue targets from this program, they expect this in-house lease-to-own offering should add approximately $25 million of incremental annual operating income by fiscal 2025. Looking at the softness in consumer spending due to inflation, I think the in-house lease-to-own program can prove helpful for the company in retaining back those customers who would either prefer to trade down or shift their spending toward more off-price retailers. However, it is too soon to comment on the amount of traction it can gain and I would like to see it for a couple of quarters before becoming more optimistic about its success.

Store-within-a-store

There is another area of a strategic initiative that the company has recently started working on. It has entered into a partnership with Belk, Inc. to pilot a store-within-a-store concept beginning in Q3 of this year. The company believes that through this partnership, they will be able to offer Belk’s customers complementary product categories, in-house repair, and next-day white-glove delivery. For fiscal 2023, the company is planning to open 10 to 14 stand-alone locations and 10-20 store-within-a-store locations, all within existing markets, which will leverage fixed costs. Store-within-a-store will require approximately $100,000 of capital investment plus display inventory. Though management has not provided any numbers on how much revenue they expect to add from this partnership, I believe it can improve the company’s return on capital. This program will also help the company leverage its supply chain capabilities. Talking about it on its last earnings call the company’s CEO, Chandra R. Holt said:

…so if we take a step back and look at what we’re doing with the Belk relationship, one of the things that drew me to Conn’s was our best- in-class supply chain for non-conveyable goods. Today, that best-in-class supply chain is mainly serving a narrow — a pretty narrow market segment of the market. So my ambition is to be able to utilize our supply chain and service capabilities for a much, much broader market. So to do that, we either have the option of changing or bifurcating our own real estate and marketing strategies or we partner with retailers who are already over-indexed in an incremental customer segment, which that’s where we see Belk having a customer segment that we don’t necessarily serve today”.

So, not only will the company benefit from increased sales as a result of this initiative but it will also be able to make use of its current supply chain logistics capabilities. I hope to see some improvement in the sales trend starting from the back half of the year as the company opens store-within-store starting Q3.

Valuation and conclusion

Fear of rising inflation and a challenging macro environment has resulted in a significant correction in Conn’s stock price. The stock is trading at 13.31x its current year EPS estimates. Though management is taking initiatives to improve sales, rising interest rates and its impact on consumer spending is a major headwind for the company. I would like to wait on the sidelines for a couple of quarters and see the kind of traction the company’s initiatives are gaining before becoming more positive about the company. I have a neutral rating on the stock.