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Published: July 6, 2010
Americans are a materialistic people. We like our home theatres,
our furniture and our appliances. Unfortunately, not everyone
can afford a new refrigerator or television, so they choose to
rent instead of buy.
The great news for investors is that this turns out to be an
extremely lucrative business, because those renters end up
spending more to rent than if they'd just bought.
At first glance, the home rental business might not seem
appealing to investors. It's capital-intensive because the
company must buy all the appliances, have a delivery
infrastructure, a lot of rental and labor
overhead and deal with repossession. However, since most
customers have weak credit, the company can charge monthly
rental fees that are reasonable to the customer but offset
operational costs. Once those costs are offset, every month's
payment thereafter is pure profit.
Among companies in this space, I like Rent-A-Center (Nasdaq:
RCII).
The thing Rent-A-Center has going for it is that it's been in
this business so long -- since 1986. The company has its
operations down to a science. It's also the biggest player in
the field. The company owns 3,000 stores, representing a 35%
market share in the United States. Only Aaron's (NYSE:
AAN) comes close in size, but is still far behind with 1,700
stores.
Rent-A-Center helps pad revenue by offering financial services
products like short-term secured and unsecured loans, debit
cards, check cashing, tax preparation and money transfer
services in about 10% of its stores. This puts Rent-a-Center in
slight competition with the likes of Advance America (NYSE:
AEA), Cash America (NYSE: CSH), and Dollar
Financial (Nasdaq: DLLR). But while the payday loan sector
is mature, Rent-A-Center has the advantage of having these
services in-store as an adjunct, so it's incremental revenue.
The state of the economy raises an interesting issue with
Rent-a-Center. Would investors expect earnings to soar as people
turn to rentals instead of purchases, or would sales lag because
nobody is spending money? It turns out the latter has proven to
be more the case. And yet, revenues for full-year 2008 and 2009
were $2.9 billion and $2.8 billion, respectively. Profit was
$140 million in 2008 and $168 million in 2009.
What attracts me to Rent-A-Center is that even in these worst of
times, it still generated a profit and revenues were still
almost three billion dollars.
Before getting sucked in, however, it's important to examine
cash flow, debt service and capital management. In these
departments, Rent-A-Center is making all the right moves.
The company generated about $261 million in
free cash flow during the past year, so interest expense is
well covered. The company also realized its debt load was too
great and began paying it down. Now, interest expense has
declined year-over-year to $27 million from $66 million. In
addition, the company managed to trim more than $100 million in
overhead, which is why
net income rose in 2009 even though same-store sales were
down -3.5%.
Those same-store sales numbers shouldn't be too much of a
concern. As mentioned, that's simply what happens when the
economy is bad. The company says it expects same store sales to
increase by a modest +1% this year, however.
Analyst consensus targets $2.45 a share in earnings this year,
which is down from last year. But analysts expect that figure to
leap to $2.68 in 2011, a +10% increase over 2010. This equates
to a P/E of 7.6, which is slightly below its growth estimate for
next year.
Action to Take -->
Rent-A-Center makes money. It's a healthy business with little
regulatory concern. With the stock -20% off its April high, I
see a chance to jump into this stock, but prudent investors may
want to open a half-position now and wait for a possible -10% to
-15% pullback to complete the position, just to be on the safe
side.
When the economy improves, people will be dying to have new
appliances again, and I expect Rent-A-Center to lead the way.
-- Frederick Steier
Contributor
StreetAuthority |
