Is There More to Conn’s Than a New Price Target?

Art is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Conn’s (NASDAQ: CONN) reported a good first quarter earnings result on June 6 by beating expectations and raising guidance. Year-over-year quarterly revenue growth increased 25.5%, same store sales rose 18%, and retail gross margin rose to 40.3%. Wow, what a great quarter! Year-over-year growth was driven by opening 7 new stores, remodeling and expanding 22 existing stores, and closing several stores that did not meet their performance criteria. They also raised the FY2014 full year guidance as follows: same store sales growth 8 to 13%, adding 10 to 12 new stores, and earnings of $2.50 to $2.65 per share.

Of course this new guidance requires a new target price, right? If you apply a modest price to earnings ratio of 25 to their forward guidance, then the new target price is between $62.50 and $66.25 for the period ending January 2014. However, Conn’s management has a history of providing low guidance and the company has beaten their guidance by an average of 17% over the last 4 quarters. If you factor in an average earnings surprise of 17% then the target price increases to $77.50 (($66.25 x 1.17) x 25 = $77.50). But wait; there is more to this story than a new price target.

Where’s the Growth?

Conn’s had a market survey performed and the results stated that the US market could support over 200 Conn’s style retail stores. Currently, they only have 70 stores so this would mean their future growth potential exceeds 300%. If you believe furniture, appliances, and big ticket electronic purchases may have been deferred over the last several years because of the financial crisis and high unemployment then their future growth looks even better.

How do they compare to their competition?

Conn’s sells furniture, mattresses, appliances, electronics and computers. Competitors that sell similar merchandise are Best Buy (NYSE: BBY), Sears Hometown and Outlet Stores (NASDAQ: SHOS), and small private companies such as R C Willey’s. Best Buy’s latest quarterly report was not good. Their revenue was down 9.6%, domestic same store sales were down 1.3%, EPS down 35.5%, gross margins down 1.9%. Best Buy is selling assets, closing stores, and consolidating their businesses. Sears Hometown and Outlet Stores also reported a bad quarter. Revenue was down 3.5%, same store sales down 5%, EPS down 27%, gross margins were up 0.1%. The increase in their gross margin rate was primarily driven by the conversion of company-owned stores to franchisee-owned stores. Bottom line, I do not see much growth for either Best Buy or Sears Hometown and Outlet Stores in the next several quarters. Both of these competitors appear to be in a reorganization or turnaround phase of their business.

What differentiates Conn’s in the market place (aka their moat)?

Conn’s competitive advantage over Best Buy, Sears Hometown and Outlet Stores, and other retailers selling the same product mix is their proprietary in-store credit program serving a sub-prime blue collar class consumer. Conn’s has over 45-years of experience serving this customer and has developed the techniques necessary to service and collect these debts. There are substantial barriers for other retailers trying to finance these products to a sub-prime borrower. Due to high loan losses and other regulatory issues banks are not interested in this business.

Conn’s offers a viable alternative to the sub-prime customer that typically goes to the Rent-to-Own retailers or simply buys used merchandise. Conn’s has discovered these customers are more interested in the financing options than discounts on products. This has allowed Conn’s to reduce the number of discounts they offer on products which has increased their profit margins to 40.3%. Conn’s has learned how to target these customers in their advertising campaigns and now locates new stores in areas where these customers are most likely to shop. Their credit program is a profit center within the company that helps increase store sales on merchandise with higher profit margins. With this business model, management feels it can maintain an average gross margin of 38% into the future. The increased same store sales and high profit margins demonstrates that Conn’s new business plan works and they are able to exploit this niche market that other retailers are not able to serve.

Conclusion

Analysts target prices range from a high of $67 to a low of $49 with 8-analysts rating it a buy, 1 rating it a hold and none with a sell rating. These analysts may not fully value the niche market that Conn’s is able to serve and the competitive advantages they have in this market. With growth prospects exceeding 300% and profit margins of 38% the future looks bright for Conn’s.

Over the next 3 to 5 years, Conn’s new business plan, marketing plan, and new store layouts should allow them to take market share from their competitors and provide services that blue collar families need. From their latest financial report and forward guidance it may be possible for Conn’s to triple or quadruple their size. You may want to take a look at Conn’s. This company may make a nice addition to a portfolio.


Art Crabtree owns shares of Conn's. The Motley Fool has no position in any of the stocks mentioned. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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