Conn's Inc. (CONN) is trading sharply higher today (+27%) after reporting surprisingly strong Q4 (Jan) earnings this morning. CONN is an furniture/electronics/appliance retailer primarily in Texas but has stores in other southern states as well. CONN currently has 110 locations, with roughly half in Texas. Their typical customer is generally lower-to-middle income ($40K average). CONN sees itself as different than most retailers. Its core customer is blue collar, working class with a 550-660 FICO store, which is a growing segment of the market. CONN's credit offering is what differentiates it from Best Buy etc.
Its customers do not have the best credit so they would otherwise have to go to a rent-to-own store where monthly payments will be much higher. CONN makes it possible for these consumers to buy brand name, higher price point products with its credit offering. Because CONN's underwrites its own financing, it considers more variables than a bank would, including how much profit it's making on the sale itself. Keep in mind that CONN's prices are competitive but they are not the cheapest on the block so that helps mitigate the increased credit risk.
Also, think about when you shop at BBY and how many people use credit cards etc. At CONN, only a small percentage of sales are on cash or credit card. The vast majority of sales are in-store credit-based. As such, this credit offering is really the draw that gets these lower income consumers in the door. Also, this credit arrangement leads to a high level of repeat business and since many customers pay monthly in-store, that generates good foot traffic for potential additional sales.
Turning to the Q4 (Jan) results, non-GAAP EPS declined to $0.05 from $0.11 in the prior year period. However, a sizeable loss was expected by the market so to report a profit was better than expected. Revenue fell 5.3% year/year to $432.8 mln, which was below market expectations. Looking ahead, CONN expects to return to full year profitability in FY18 after reporting a non-GAAP loss of $(0.22) per share in FY17. On the retail side, retail operating margins (adjusted) in JanQ improved to 16.0% from 12.9%.
CONN says that FY17 was a transitional year, focused on improving its credit operations, which has been a difficult area for them. While much of the focus during FY17 was on turning around the credit operation, Conn's retail business performed well. CONN says its credit operation continues to benefit from the structural changes being made to increase yield, reduce losses and improve credit segment profitability.
A big change CONN has been making is to tighten credit standards and, in 2016, it received regulatory approval to begin offering direct loans at higher rates of near 30% for customers in Texas (its largest state in terms of sales), up from a previous cap of 21%. At the same time, CONN has been increasing loan terms so that monthly payments are roughly the same. CONN has realized that its customers are payment buyers. They are not focused on interest rates, but rather the monthly payment amount. CONN will benefit from the higher interest rates to reduce their risk.
They have been making progress. During JanQ, all originations in Texas were under Conn's new direct loan program, and in early March, it fully implemented its direct loan program in Louisiana. Over 80% of current originations now have a weighted average interest rate of over 28%, compared to almost 22% in September. CONN also recently announced a partnership with Progressive Leasing to significantly expand Conn's lease-to-own sales.
Looking ahead, CONN is optimistic that overall credit results will improve throughout fiscal 2018, as legacy accounts leave the portfolio and are replaced with accounts benefiting from tighter underwriting and higher yields. This should help CONN return to profitability in FY18.