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Conn’s (CONN) Subprime Customers Affecting Company Shareholders

September 02, 2014 | About:

Conn’s (CONN), a specialty furniture and mattress retailer, which also provides credit to incentivize customers, reported disappointing quarterly results due to worsening credit delinquencies. Conn’s lowered full year EPS guidance to $2.80-$3 from $3.40-$3.70. Higher expenses and provisions for bad debt have resulted in a CONN price decline of 30%.

Top Line Growth Not Trickling Down To Profits

On the quarter, Conn’s total revenues saw a 30% increase over the same period a year ago. Thus far in 2014, revenues have risen 32% over 2013. Additionally, the company improved margins by approx. 200bp, yet higher than expected SG&A, provisions for bad debts and interest expenses have eaten at profit margins.

SG&A was reported at 30% of revenues, a historically high figure when compared to the 28-29% expectation. The company projected that for the full year 2014, this figure would settle back down to 28.5% – 29.0% of total revenues. This appears to be a temporary spike that should be fixed in the near term.

The more alarming costs, however, are due to the 75% YoY increase in bad debt provisions that Conn’s has experienced in 2014. As management has warned, this is expected to worsen.

“The rate of customers failing to pay their debts after two months will probably reach historical highs in the second half of the year”

Will Actions Taken be enough?

Conn’s has implemented tighter underwriting policies and issued $250M in 7.25% senior unsecured notes back in July to improve liquidity. As of July 31, 2014, the company had $361.2 million of borrowings outstanding under its asset-based credit facility, $4M in cash and $607M in debt.

Building a customer base with subprime credit is not a winning formula. Conn’s collecting troubles are a result of high delinquency, which goes back to programs like no or low interest on purchases to attract customers. Tighter policies may result in slower growth, but better overall financials.

Final Thoughts: Traders Trade, Investors Wait

Conn’s same store sales grew at 11.7%, a good measure of retail growth. The company opened eight HomePlus locations during the quarter, closed one store and remodeled or relocated three others. These expansion plans are going to continue into the second half of 2014. Investors should wait and see how the tighter credit policies are implemented and the effect these underwritings will have on the financials. If collections improve at the cost of top-line growth, I would consider such a move beneficial to Conn’s overall business. Jumping in at these deflated values could end up burning investors if credit delinquency rates continue worsening. It’s best to wait.

For short term traders, I believe the stock price will see a bounce due to the high short interest rate (below). CONN is down 30% today (60% YTD), so it’s likely that a good number of shorts have taken profits. This should reduce selling pressure and provide a temporary bounce. The longer term trend depends on how the company deals with subprime credit.

CONN short interes

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Comments

batbeer2
Batbeer2 premium member - 3 months ago

Thanks for an interesting article.

You say:

>> Building a customer base with subprime credit is not a winning formula.

I think it is.

Credit scores are only important for businesses that do not know their customers. Using a credit score means you rely on some elses expertise to asses your clients ability to pay.

Now that is not a winning formula.

Conn's relies on it's own assesment of their customers ability to pay. Over time a local franchise will come to know its customers very well.... but there's a learning curve. That is also the barrier to entry. You do not want to set up shop next to an existing Conn's providing the same service. If you do, you will get all the customers they turned away (customers Conn's knows won't pay). You will be bust in no time.

I wonder how many new shops Conn's opened in recent years and if the deliquencies are from old shops or new ones. If it is the latter, then collection is likely to improve going forward.

Just some thoughts.

Anyone care to look into the number of new stores and/or the source of the deliquencies?

Last Financier
Last Financier - 3 months ago

Good points batbeer2.

  • As management said in their conference call (http://seekingalpha.com/article/2466205-conns-conn-ceo-theodore-wright-on-q2-2015-results-earnings-call-transcript), the plan is to open 18 stores in fiscal 2015.
  • Four stores closed through August and plan to close an additional six stores over the course of the fiscal year. Company also plans to open 15 to 18 stores in fiscal 2016
  • Over the last five months Conn's has opened an additional 14 stores in 11 markets
  • Therefore, in many markets, there are multiple Conn's stores mixed with existing ones. Probably not in the same area as you mentioned as this is not smart business. The growth is there and all points indicate that it should continue.
  • The company does not give source of the deliquencies, however management did say that there isn't a telling difference between new/existing markets. Deliquency rates are the same across the board.

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