After a Steep Drop, Is the Story Still Intact at Conn's?

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Source: Conn's website

Investors in appliance retailer Conn's have been singing the blues in 2014. There was a sharp share-price decline in February after the company issued a poor quarterly financial update that included rising customer payment delinquencies. 


To make matters worse, the company also reduced its profit expectations for the coming fiscal year. The bad news put a damper on Conn's multi-year profit expansion story, which had led to a strong stock price performance over the past few years. However, with the company's shares now selling at a discount, is Conn's a good bet?

What's the value?
Conn's has successfully navigated a challenging retail environment by limiting its operations to a tight geographic area surrounding its home base of Texas, operating its network of roughly 80 stores in just a handful of states. The strategy allows Conn's to leverage its marketing and distribution costs across a meaningful number of stores, helping to offset its relatively low merchandise margin. The company is also an active participant in the financing of customer purchases; it funds roughly 70% of total sales, which provides a high-margin source of ancillary revenue.

Despite coming up short in its latest financial disclosure, Conn's has performed relatively well in FY 2014. It reported a 35.5% top-line gain through the first nine months of the year thanks to double-digit sales growth across its major product categories; performance was led by a torrid 70%-plus increase in the furniture/mattress area. 

More importantly, the company's focus on the high-dollar-value appliance and mattress product lines has led to greater volume for its high-margin financing operations, providing a boost to Conn's operating profitability. The net result has been higher cash flow to fund inventory purchases and its store expansion program, as Conn's attempts to capture more customer market share in both existing and new geographies.

Looking into the crystal ball
Of course, a big part of Conn's story is its financial operation, which allows it to ring up sales that would otherwise go by the wayside. A reduction in its overall financing capabilities, potentially due to rising delinquencies, would put a crimp in Conn's growth story, making it look more like competitor hhgregg .

Despite a fairly similar product sales mix as Conn's, hhgregg has a notably worse operating margin, hurt by a lack of an internal financing operation. The company also has a much wider geographic footprint than its smaller rival, operating its store network across much of the eastern half of the U.S., including recent expansions into the Chicago and Milwaukee metro markets. hhgregg's greater geographic diversity gives it a more diverse customer base, but it also limits the company's ability to gain significant scale efficiencies in what is essentially a commodity business.

Strength in numbers
Conn's is well positioned to continue benefiting from purchases of appliances and furniture by a growing crop of new homeowners, notwithstanding recent housing market weakness. The negative trend in customer payment delinquencies, however, adds some uncertainty to the company's profit growth story. As such, investors looking to ride the appliance sales boom should probably take a pass on Conn's in favor of home improvement retail giant Home Depot , one of the country's largest sellers of appliances.

Home Depot, as well as competitor Lowe's, has been one of the biggest beneficiaries of the improving national housing market. The favorable condition has brought a rising number of customers into its stores, leading to an uptick in transaction volumes in its latest fiscal year.  The company has also been hard at work trying to get those customers to up their purchase levels. It has done this partially by offering a larger selection of appliances from popular manufacturers as well as through incorporating a greater number of energy-efficient, EnergyStar certified products into its lineup. 

The company's efforts in that area brought a good harvest to shareholders in FY 2013, helping to produce higher average transaction values and a strong 18% increase in Home Depot's operating income. More importantly, Home Depot's sizable free cash flow is providing surplus cash to invest in even greater product selection, furthering its competitive advantage against its rivals.

The bottom line
Conn's recent harrowing stock drop is pretty indicative of a market that believes the company's recent profit growth story may be coming to an end. While Conn's is certainly cheap, at a below-market P/E multiple of approximately 14, prudent investors should probably search for greener pastures elsewhere.

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The article After a Steep Drop, Is the Story Still Intact at Conn's? originally appeared on Fool.com.

Robert Hanley owns shares of Conn's. The Motley Fool recommends Home Depot. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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