Introduction and Investment Thesis

Conn’s (CONN) is a retailer focused on providing home furnishings and other consumer goods via 137 retail stores across 14 states. Out of this 137 store footprint, around 64 are located in Texas, which poses a degree of concentration. However, the Texas market is a strong one with significant population growth of nearly 8% from 2014-2019 and is the second largest state by GDP in 2019. Thus, despite the company’s concentration in this state, I believe that there are significant demographic tailwinds alongside a large market opportunity that will help the company grow over time.

Overall, the company provides a strong omnichannel offering with both an e-commerce and in-store shopping modality (~25K-50K sq. ft. on average). On top of this, the company provides a highly differentiated credit offering which helps largely subprime buyers purchase furnishings.

This credit offering is honed with the company’s strong 50-year plus data set allowing the company to offer compelling terms to the customer while minimizing credit risk. This offering includes proprietary and differentiated underwriting models and customer risk assessment models. Depending on the customer’s credit score, the company either offers a no-interest or low interest option for customers with high credit worthiness. For more subprime borrowers, the company offers fixed term and fixed payment installment loans at higher interest rates.

Looking at the company’s most recent quarterly results, the company’s performance was not great but understandable given the pandemic with sales largely down YoY to $280 million from $306 million the year prior. However, the company is still net income positive, which is key for getting through this pandemic. This is particularly so given that the company has sufficient liquidity to fund operations for the foreseeable future.

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However, diving in a bit deeper, things are not as bad as it seems. Yes, the revenue decline is an issue, but this was at least partially driven by tighter underwriting standards that drove a negative double-digit impact on sales. But, these actions are helping maintain the credit quality of the company’s borrower base. Additionally, these underwriting standards should normalize in a post-COVID environment and will no longer be an impediment to growth. Similarly there were supply chain issues, as seen in many other parts of the retail sector, that should also normalize post-COVID. The company does expect Q3 to be stable vs. Q2 so it does feel like there could be good support for the stock at these levels. Management is similarly bullish on the business and is still planning to open up to 9 stores next year. Credit quality is also holding up. Although delinquencies and charge-offs are up YoY, it does seem to be stabilizing. All-in-all, the company is executing well through this pandemic, but is still taking a hit to performance.

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However, in order for the stock to meaningfully re-rate, I believe we need more than vaccine news. We need to see actual top-line improvements flow through which will likely take some time. Although the recent vaccine news is a positive, I hardly consider it to be a panacea as it will likely take time for manufacturing to scale and it is still hard to see what true adoption will be. Thus, I remain on the sidelines at this time.

Risks

The company’s primary competition comes from a large set of retailers such as Costco (NASDAQ:COST), Walmart (NYSE:WMT) and Target (NYSE:TGT), as well as other more specialized retailers such as Best Buy (NYSE:BBY), Mattress Firm, and Home Depot (NYSE:HD). To be clear, although Conn’s has a strong differentiation around its proprietary credit offering to subprime customers, this is also something that other retailers are beginning to roll out. However, I believe that the company operates in a large enough market and has a large, loyal customer base that the company will still be successful even if competitive pressures increase.

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Conn’s being in the retail space has also been negatively impacted by the COVID pandemic. Due to stay at home orders, stores had to be shut down and occupancy limits further impacted sales growth. This pandemic also drives a significant amount of uncertainty into the business and makes it difficult to forecast performance or gain visibility into a possible inflection in demand. Furthermore, by lending to a subprime customer base, continued pandemic related economic disruptions may impact these customers’ ability to pay. This in turn may have a negative impact on the company’s financial results.

Valuation and Conclusion

Valuation is a tricky one. The company’s PE ratio has come down considerably in recent months. This is likely justified just given COVID related headwinds. So, arguably, the stock is cheap at these levels if you believe that a recovery will happen in the near-term. The company also has a differentiated credit-forward retail operation in a growing market. However, given the uncertainty of timing of a recovery, I will be on the sidelines at this time.

ChartData by YCharts

Disclosure: I am/we are long CONN. 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.



Via SeekingAlpha.com

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