Louisiana-based electronics retailer, Conn's (Nasdaq:CONN) has been talked about a lot recently. Many investors favor the company over its main competitors - Best Buy (NYSE:BBY) and HHGregg (NYSE:HGG). But how does Conn's really stack up in this economic environment, considering the private label credit card business and the part it plays in the retail industry?
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Two Businesses in One
When you buy Conn's stock, you are actually buying two businesses: an electronics retailer and a financial services company. Several retailers operate their own credit departments, including Target (NYSE:TGT), Conn's and others. Recently, plus-size retailer Charming Shoppes (Nasdaq:CHRS) sold its credit business to Alliance Data Systems (NYSE:ADS) for $110 million. That's a good chunk of debt off the books, while retaining its core business. Retail's difficult enough without spending half your time worrying about whether or not your customers are going to go broke and stiff you on that 72-inch LCD television. Company management swears it has a handle on this, and it likely does, but it has to be a distraction.
Valuing Each Business
In order to come up with a value for Conn's, as a whole, the value of each business (separately) must be figured out first. Paying $110 million, Alliance Data Systems bought approximately $580 million in receivables. This translates to$1 for every $5.30 in receivables. Granted there is one major difference between Conn's and Charming Shoppes credit programs: Conn's has both a primary portfolio, as well as a secondary portfolio (for those who don't qualify for the primary portfolio), which might make its value to a would-be buyer that much more attractive, due to the additional finance charges. To be on the safe side, we'll add an additional 10% to whatever number we come up with, and hopefully that puts us in the ballpark of what a real buyer would pay.
Conn's 2008 10-K only reveals the yield on outstanding receivables. It doesn't break down all of the expenses of running its own credit program, whereas Charming Shoppes does, so to be fair, we'll use Charming Shoppes gross revenue in 2008 from its credit program (rather than its net income after operating expenses), which was $98.5 million on an average receivables portfolio of $579.3 million for a yield of 17%. Conn's generated $85.7 million in finance charges from an average receivables portfolio of $696.2 million and a yield of 12%. Surprisingly, Charming Shoppes appears to have had the more profitable finance business in 2008. Nonetheless, Conn's credit business has an approximate value of $144.5 million, or $6.43 per share.
What's The Retail Business Worth?
The average price-to-sales ratio of competitors Best Buy, HHGregg and Radio Shack (NYSE:RSH) is 0.42. Conn's 2008 net sales, excluding the finance business, was $805 million, which, multiplied by the Price/Sales average, gives an estimation of the value of the retail business at $338 million (or $15.05 per share). Adding both together shows a value for the entire business of $21.48, an 88% premium to its current stock price. On the surface, it would appear that Conn's is a compelling value investment. However, there's a big "but." (Learn about other useful price multiples in the ratios section of our CFA Tutorial.)
Bottom Line
Conn's second quarter report wasn't a complete disaster, but it wasn't anywhere close to being promising. It appears Texas is heading into the economic abyss just as the rest of the country is slowly pulling itself out. Management cut full-year earnings to $1.40-1.60, from $1.75-1.85, set aside $2.7 million in bad debt reserves (up from $300,000 year-over-year) and indicated its net charge-off rate for its credit portfolio was 3.4%, up 40 basis points from the first quarter. Add falling sales and lower operating margins to that, and the future isn't very rosy. Perhaps Conn's would be better off if it sold the credit business as fast as humanly possible so that it can focus on turning around its electronics business. Otherwise, this stock will always be misunderstood and undervalued. (Read Analyzing Retail Stocks to learn about the most important metrics to look at when analyzing retail stocks.)
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