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The bull case for Conn's

February 13, 2010 | About:
1) I really really don't like math so I use round numbers to make life easy. The source of most of my numbers is the latest (amended) 10q for the quarter ended october 2009.

2) This is not an idea from the Buffett schism of the church of value investing.

3) Hat tip to Jae Jun and Stockdocx99 for bringing this to my attention.

http://www.gurufocus.com/news.php?id=84259#84518

http://www.gurufocus.com/news.php?id=72582


Investment thesis

Current assets of 425m minus all liabilities of about 225m equals 200m. Mr. Market offers us the company for 100m. Not only are the fixed assets free, we get a huge discount on the current assets after paying all the debt. Barring some event destroying a lot of shareholder value, this company is worth twice the price.


The opportunity exists because

a) The consensus outlook for consumer spending is not good.

b) The trend of receivables, sales and inventory indicates poor management.

c) It is unclear if buyers can afford the items they purchased on credit.


a) The demise of Circuit City is a good thing for Conn's. In a bad general economy, the closure of Circuit City brings new customers into Conn's stores.

b) A classic red flag for a retailer; in this case it is a deliberate move by the management of the bank part of the business. Keep in mind:

- Conn's normally transfers (securitises) its receivables to an off-balance sheet qualifying special purpose entity (QSPE). The QSPE's funding has reached its limit; they are unable to sell more debt. Excess receivables are now reflected on the balance sheet. The problem can be solved by contraction of the retail operations or by expansion of the QSPE. The latter may or may not be possible in the near future. The point being that this trend is NOT an indication of poor management of the retail business.

- Conn's decided to accumulate receivables on its balance sheet in the first half of 2009. Securitisation of consumer debt just wasn't an option at the time.

- Business is seasonal; receivables max out in december; inventory before that.

c) More than half the companies sales are on credit. That is where the profits are and that is the core of its business model. The receivables on the balance sheet may be worth less than the securitised debt but there is no indication they are worthless. Either Conn's retail operations contract and the receivables work their way through to the bottom line in time or Conn's manages to securitise the excess receivables on decent terms and we have a growth story.


Earnings power

Assets are a good starting point to look for downside protection but a company will go bankrupt if it runs out of cash.

Conns has 125m of debt. With average EBIT of 50m and a record low EBIT 25m (my estimate) for calendar 2009; interest seems well covered under the worst of conditions for a retailer.

EBIT is not the same as cash though. The ability of Conn's to service its debt depends on its ability to collect from its customers. Interest income (cash) from the securitized receivables portfolio (150m) is 20m. This does not include:

- Any cash from the 150m of receivables on the balance sheet. Say 10m (conservative) going forward.

- Income from direct sales (not on credit); including cash commissions earned on insurance sold. No idea going forward; say 0m.


Management

The CEO and the Chairman have been with the company since the nineties. The CFO joined in 2004. Total compensation for key executives as a group is ±5m.


Risks

The company has the risks of both a retailer and a bank.

- No moat

- Questionable assets

- Seasonal as well as cyclical

- the 20 000 other risks I have not thought of yet.


Conclusion

Upon analysis, the common stock of Conn's promises safety of principal and an adequate return.

Any and all questions welcome as usual.

About the author:

batbeer2
I define intrinsic value as the price I would gladly pay to own the business outright. With current management in place. For most stocks, that value is 0. As of September 2012, I'm the author of the monthly Buffett-Munger Best Bargains Newsletter. I can be reached at fvandenbroek AT gurufocus DOT com

Visit batbeer2's Website


Rating: 4.2/5 (13 votes)

Comments

munger
Munger - 4 years ago


Conn's is a deep value and as you noted, there is a lot of risk on those assets. Can they move inventory? Can they convert the receivables to cash? Can they absorb losses from their credit portfolio? Big questions.

Conn's will probably end up being a situation where you either make 100%+ or lose it all by going long on the common - a lottery ticket so I would say small bets only.

Retailers that have a more certain future have already rallied and gained market share on the walking wounded.
batbeer2
Batbeer2 premium member - 4 years ago
Conn's will probably end up being a situation where you either make 100%+ or lose it all

Any thoughts on a likely event causing equity to be wiped out in this particular case ?
munger
Munger - 4 years ago
batbeer -

Probably more of a figure of speech than literally. But think about it - it was $6+ just last month and looked cheap so you could already have some serious unrealized losses. It could go $1-2 and in my book, that's wiped out.

It's a weak player in an incredibly competitive sector and in a very tough recession.

WEB Law - #1 don't lose money, #2 don't forget #1

superguru
Superguru - 4 years ago
"Conn's will probably end up being a situation where you either make 100%+ or lose it all"

What I am learning hard way is that I am not knowledgeable, discerning and sophisticated enough to judge bets like this.

I thought GGP , CIT and UFS as too risky and Rhie as a good bet to double money. Obviously I am not yet ready to play this game.

Not sure why thought that way because GGP and UFS have real assets.

So I will avoid these kind of bets till I know better.

Also I will start writing down reasons of my investing decisions and have a written checklist.
Ranni
Ranni - 4 years ago
(The bull case)

”batbeer2 The point being that this trend is NOT an indication of poor management of the retail business.”



I don’t know, is this next Circuit City, but their accounting practises definitely raises legitimate concern. Their only problem is not poorly managed retail operations (unable to generate cash), but moreover, lack of management accounting disciplines. They failed to provide information which is relevant and verifiable (hiding true business conditions), They are unwilling to take losses, rather kicking the can down the road. In this particular situation, bearish case about Conn´s books seems more valid in my eyes.

batbeer2
Batbeer2 premium member - 4 years ago
Their only problem is not poorly managed retail operations (unable to generate cash),



Why do you conclude that the retail operation is poorly managed ? They were formerly able to securitise their receivables by "selling" them to the QSPE. The QSPE would let the receivables run out. The act of moving the receivables to the QSPE caused FCF to be recognised sooner. Without the use of the QSPE, earnings take longer to drop down to the bottom line. but they will drop down in time, same as before. These receivables take 1 to 3 years to work out. This has always been so, this time is NOT different. We are talking 60% of sales here.

Keep in mind that the company always did mange the receivables even after they had been transferred to the QSPE. They now manage the same receivables but they are on the balance sheet. If customers defaulted before, cash would cease to come from the QSPE; same as now.

Other than the problem of not being able to expand a fully utilised QSPE which has been caused by:

a) growth of the business

b) the inability to sell debt in the open market

I see no evidence of can-kicking but please correct me on this point. If anything, without the QSPE things are more transparant.

There is the possibility that the numbers are just a figment of management's imagination but again, I see no evidence of that. If this is a poor mans Madoff, then it's a very crude Madoff.
batbeer2
Batbeer2 premium member - 4 years ago
There was a similar situation with crox:

It was first a contrarian "play"

http://www.gurufocus.com/forum/read.php?2,25650,page=1

Then a carefull analysis of business developments gave rise to concern:

http://www.gurufocus.com/forum/read.php?2,32991,36936#msg-36936

Soon after, the stock traded at a discount to net current assets; for months it traded at less than $2. There were accounting issues, inventory problems and bad revenue trends.... the bears were right !

Buying then would not have been a bad idea; Cigar butts work ! Just pay less than nothing for the business. Or...... be the last bull standing after even the tough gurufocus crowd has given up ;-)
batbeer2
Batbeer2 premium member - 4 years ago
The market cap of 240m renders this thesis invalid.
DaveinHackensack
DaveinHackensack - 4 years ago
Did you buy the stock when you wrote this idea up? Are you selling it now?
batbeer2
Batbeer2 premium member - 4 years ago
No. I switch only when I perceive one stock to be 50% cheaper than another; this was not the case. Conn's was "only" 50% undervalued by this thesis. I would have to sell a fully priced stock. At the time I had none in my portfolio.

Also, I had no excess cash and I perceived none of my holdings to be mistakes. My trading rules made me pass on this one. I have no regrets; these rules have served me well on other occasions. It's not the errors of ommission that kill you; it's the errors of commission.

My US holdings are here:

http://www.gurufocus.com/my/func.php?action=overview&uid=35024&id=4181

batbeer2
Batbeer2 premium member - 4 years ago


.... and I probably would be selling now.

IMHO Conn's is not a company for the Buffett schism of the church of value investing. By which I mean it is not a potential permanent holding for me.
batbeer2
Batbeer2 premium member - 4 years ago
The current market cap of 150m renders the thesis valid once more. This time round, I'm buying. I found some cash I don't need.

The company is priced for disaster - maybe rightly so - but I see no indication that the business itself has changed for the worse. The greatest change is in the accounting. They no longer offload the receivables.

A retailer that remained profitable in 2009 ! - rare

A consistently profitable NCAV ! - very rare.
batbeer2
Batbeer2 premium member - 4 years ago
On the off chance that there is still some interest in profitable NCAVs......

It just struck me that this company has a durable competitive advantage. Conns has been doing business in the southern states for a long time. Close to 60% of sales are done through the in-house credit department. These guys know their customers.

Imagine you want to open a store selling appliances on credit in this region..... any customers they refuse credit will come to you; these are probably not the customers you want. This company may or may not have the risks of a bank, but it certainly has the advantages of a regional bank.

The accountants have been rewriting the balance sheet lately (no significant change in the underlying assets mind you) but this is still a deep NCAV.

disclosure, long CONN
batbeer2
Batbeer2 premium member - 4 years ago
http://www.sec.gov/Archives/edgar/data/1223389/000115752310005991/a6478463ex991.htm

Conn's is issuing shares for cash.

Shares drop by >20% to less than $3 on this news.

In conjunction with plans to refinance its existing debt facilities, the Board of Directors approved a possible rights offering which would permit the Company to raise equity capital through the sale of common stock without diluting existing shareholders who exercise their rights in full. Shareholders of record as of the close of business on November 1, 2010, would receive one right for every share of common stock held by them as of such date if a rights offering is commenced. While the size of the offering, exercise price of the rights, and other material terms would be determined and announced at a later date, the Company expects the rights would be tradable, thereby allowing existing shareholders that are not interested in exercising their rights to sell their rights in the public market. The Company also expects the rights to carry oversubscription rights, which would allow holders who exercise their rights in full the opportunity to subscribe for additional shares of common stock to the extent rights were not exercised by other holders. Certain affiliates of Stephens Inc. and of The Stephens Group, LLC that own approximately 21.3% and 26.0%, respectively, of the Company’s outstanding shares of common stock, have indicated to us that it is their present intention to exercise their basic subscription rights and oversubscription rights in full, subject to their review of the final terms of the possible rights offering to be determined by the Company and announced on the commencement date.
softdude2000
Softdude2000 - 4 years ago
offering which would permit the Company to raise equity capital through the sale of common stock without diluting existing shareholders who exercise their rights in full.

How can I have a cake and eat it too! Are they saying you are not diluted if you buy more shares with cash from your pocket. Oh, I can have a cake and eat another cake if I empty my pocket. Did I understand it ?
batbeer2
Batbeer2 premium member - 4 years ago
Did I understand it ?



Yes, it's dilutive but they did not lie.... it's not dilutive IF (big if) you buy the extra shares. In that case, your slice of the company remains unchanged. Your cost for that slice goes up though.

And yes.... I don't like it if a company sells shares at prices well below NCAV.
softdude2000
Softdude2000 - 4 years ago
It is amazing how creative people are in writing this crap. May be there is a training on how to write financial BS. When I am reading annual report, sometimes I have to read again and again just to know it is BS. It is more effort to weed out trash than to read what is useful.
batbeer2
Batbeer2 premium member - 3 years ago
Conn's releases earnings and guidance. They expect to earn $ 0.70 per share.

Shares run up 35% to $ 7.4.
munger
Munger - 3 years ago
Did you hand on through the big drop prior to the rally? Your last update on a long position was Jun '10 and it sank to $3+ before the $7.4.

batbeer2
Batbeer2 premium member - 3 years ago
I'm going to regret this but I am selling now; COCO is obscenely cheap.

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