|Shares Out. (in M):||31||P/E||0||0|
|Market Cap (in $M):||233||P/FCF||0||0|
|Net Debt (in $M):||1,167||EBIT||0||0|
We believe CONN has the potential to be a $50 stock in the next 18-24 months, v the current price of ~$8 today.
Note: This write-up will be brief, as CONN reported earnings this morning. We believe the company's disclosures were materially positive and wanted to share our views in a timely manner.
The key to the CONN investment is that we believe that management will be successful in transforming the Credit business from a PNL drag to a PNL contributor. We believe that the actions take by CONN can turn the Credit business from a $4.00 per share EPS drag to breakeven profitability, with the potential for Credit to be a significant profit generator for CONN.
In our upside case, we assume that CONN will earn over $4.00 in EPS in 2018 (Retail business ~$3.00, Credit business ~$1.00), which at an 12x multiple, would yield a >$50 stock. Our base case assumes ~$2.75 in EPS (~$2.65 Retail; ~$0.10 Credit), which at a 10x multiple would yield a $28 stock, which is still nearly ~4x the current share price.
BRIEF OVERVIEW OF CONN
CONN has been written up on VIC three times in the last three years, twice as a long, and once as a short… A quick look at a 5-year chart shows a stock that went from $5 in 2012, up to $80 in 2013 (that is not a typo), and now back to $8 currently. Lets just say the shorts are currently winning, but it may be time for the longs to have their day!
CONN is one part retailer (selling furniture/mattresses/home appliances, etc through its retail stores) and one part consumer finance company (financing the majority of their customers through installment credit). At the risk of oversimplifying, since 2012, CONN offered more and more credit to its customers, which allowed them to generate more sales and open more stores, which allowed them to extend more credit, which allowed them to generate more sales and open more stores… and so on and so on… it was a virtuous cycle that repeated until it didn’t… ultimately, CONN had extended too much credit to too many people and the Credit side of their business started to have real issues a few years ago.
As it stands now, CONNs Credit business, which historically had been consistently profitable, is now losing over $4.00 per share in GAAP earnings. CONNs Retail business has largely been subsidizing the Credit business, with EPS of ~$3.50. Still CONN today is unprofitable, and the stock price (near the lows) clearly reflects that.
About a year ago, new management team was brought in to turn around the operation. We believe that the efforts that the new management have taken are starting to bear fruit, and that the Credit business can return to breakeven (or even a profit), with minimal impact to the Retail business. We believe this will result in dramatically improved earnings power for CONN, which should result in a dramatically improved share price.
CREDIT BUSINESS DETAIL
Below we detail a snapshot of what CONNs credit business looks like currently. CONN has $1.55bn in receivables (loans to customers), which generate $286mm of interest and fees, but are offset by more than $450mm of operating expenses, provisions and interest expense, leading to sizeable losses.
|$||% of Rec|
|Interest and Fee Yield||286||18.5%|
|CREDIT ESTIMATED BVPS||$4.5|
|CREDIT ESTIMATED ROE||-88%|
Below is a snapshot of how we think CONNs credit business will look in our base case. We believe that through a combination of increased fees, lower provision expense, and lower interest expense, CONN can bring the Credit business back to breakeven.
|$||% of Rec||$||% of Rec||Bps Ch|
|Interest and Fee Yield||286||18.5%||399||25.9%||735|
|CREDIT ESTIMATED BVPS||$4.5||$4.5|
|CREDIT ESTIMATED ROE||-88%||-1%|
Interest and Fee Yield:
When CONN reported earnings TODAY, they made the following statement:
"During the second quarter, we received the regulatory licenses in the state of Texas required to offer direct loans at higher APRs to customers financed through our in-house credit offering. The direct loan program is expected to be implemented across all 55 Texas locations by the end of this fiscal year. The state of Texas represents many of our strongest markets and approximately 70% of our recent originations, which under our legacy offering had a maximum equivalent APR of approximately 21%, compared to 30% under our new direct loan program.
In addition, CONN is increasing fees on an additional 25% of receivables. Our simple math is that 95% of receivables will reprice over time at a 8-9% increase, yielding CONN an additional 700-800bps benefit in yields. The company confirmed this on the conference call, stating they expect a 600-900bps increase in yield from these actions. Again note that this is new information as of the press release this morning, and we believe is a game-changer for CONN.
CONN started making significant underwriting changes a year ago to tighten credit. Just the opposite of extending more credit, which had an immediate boost to retail sales, but a longer-tailed impact on credit costs, these changes have impacted same store sales immediately on the negative side, but the benefits of a reduced provision have yet to manifest themselves. We believe that provision expense should decline, and management is targeting a 10-12% cumulative loss rate on future vintages. We use a 12% loss rate as a pct of average receivables in our analysis above.
Last year, CONN made the choice to diversify their funding from bank loans to ABS issuance. Being a new issuer to the ABS market, CONN had to pay higher rates to get their initial deals done. As CONN 1) becomes a more seasoned issuer in the ABS market, and 2) credit costs normalize, we would expect interest costs to decline meaningfully. CONN management has stated their goal is to drive ABS costs down to 4.5-5.0% over time. We use the upper end of that range, 5.0%, multiplied by 80% LTV on receivables, to get an average rate of 4.2% on receivables.
Put all those pieces together, and a path to breakeven for Credit becomes visible. Assuming slightly less conservative assumptions (higher yields, lower losses, lower interest expense) we can arrive at >$1.00 in EPS for Credit in our upside case
See below for our valuation framework on CONN. We believe that CONN can produce over $4.00 in consolidated EPS in our upside case, which at a 12x multiple, would yield a $52 stock.
|Credit Net Revs||264||217||171|
|Est Credit EPS (FY18E)||$1.31||$0.11||($1.37)|
|Est Credit Value||$16||$1||($11)|
|Total Retail Sales||1,316||1,260||1,204|
|Est Retail EPS (FY18e)||$3.00||$2.58||$2.19|
|Target Retail (X)||12.0x||10.0x||8.0x|
|Est Retail Value||$36||$26||$18|
|Target Px (CONN)||$52||$27||$7|
|Implied (x) at Tgt||12.0x||10.0x||8.0x|
|Implied ROE (%)||26%||16%||5%|
The author of this posting and related persons or entities ("Author") currently holds a long position in the securities mentioned above. The Author makes no representation that it will continue to hold positions in these securities. The Author is likely to buy or sell long or short securities of this issuer and makes no representation or undertaking that Author will inform Value Investors Club, the reader or anyone else prior to or after making such transactions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note. The views expressed in this note are the only the opinion of the Author. The reader agrees not to invest based on this note and to perform his or her own due diligence and research before taking a position in securities of this issuer. Reader agrees to hold Author harmless and hereby waives any causes of action against Author related to the above note.
|Subject||Re: Re: ABS Numbers|
|Entry||09/12/2016 05:58 PM|
I did a roll forward analysis using each of the reports. The 429 mm of total receivables is deceiving since only 334 mm is current and that amount is eroding rapidly.
Here's what I mean - 6% (23/379) of the current balance from June 2016 was 31-60 days overdue in July 2016. That rate has been deteriorating as time passed. Once you hit the 31-60 bucket the probability that you slide into the 61-90 bucket increases to 66-77% (depending on the month). From the 61-90 bucket you begin to slide with generally an 80-95% likelihood to the next bucket. So if you hit the 31 day bucket, 40-50% of the volume will end up never making a payment and defaulting at 210 days. The ABS from a static basis of seeing 334 mm current in the month vs 156 mm Class A and 166 mm Class B outstanding may look okay but once you see that 6% rate eroding the current every month things go South in a hurry. That rate had been below 5% until May and has now gotten to 6%. Even if they bring it back to 5% and bring the % defaulting from the 31 day bucket down to 40% the Bs still don't get made whole.
To help illustrate my point, if you take the amount current and divide by the sum of the Class A & B you would get 103.9% at the end of July. It was at 108.9% in April. Next month I believe it will be around 103.5%. By Feb 2017 I think it will be around 100.2% and continue to decline. I'm wrong if they can get their progression to the 31-60 bucket back under 5% but right now its trending higher.
Their other way out is to get the customer to "buy" something else and then roll the new combined account into a new ABS while repaying the older one. That just shifts the problem from the older ABS to a newer one though. I'd prefer they take the pain and clean things up vs kick the can down the road.
|Subject||Re: Re: Re: ABS Numbers|
|Entry||09/13/2016 11:51 AM|
I think there are a couple of flaws in your analysis that are pointing you towards an impairment of the Class B bonds whereas we find impairment of those bonds to be extremely unlikely.
1) Looking at the amount of current loans vs. the balance of the bonds only understates how protected the bonds are because of the 40-50% of delinquent loans that will ultimately cure and therefore be available to payback the securitization debt. So when you divide the current loans by the outstanding balance of bonds you are not factoring in the repayments the bonds will get from recoveries on defaults or the currently delinquent bonds that will cure and become current again. On our numbers of the 95mm of bonds that are currently delinquent we estimate 66mm will actually default and those defaults will have recoveries of approximately 10% so call it 6.5mm. On top of that you have another 29mm of currently delinquent bonds that will cure and payoff. So rather than dividing the current loans by the bond balance you should subtract the recoveries and the cures from the bond balance to get a more accurate feel for how much credit enhancement there is. So 334mm of current bonds / 286mm of adjusted bonds outstanding gets you a starting coverage ratio of 117% vs. the 103.9% you start with.
2) In addition to the receivable balance in excess of the balance of bonds there is an additional source of credit enhancement from the cash reserve Fund which is 14.4mm dollars that serves as cash collateral to secure repayment of the bonds.
3) I don’t think you are factoring in excess spread which is first made available to repay bond principle and only gets distributed to the equity if the 25% collateral cushion is maintained. Excess spread will actually expand quite significantly next month because all of the loans with the 12 month same as cash option have now lapped the 12 month period and so there will no longer be any interest forgiveness. Over the remaining life of the deal the receivables will generate roughly 30mm of additional excess spread that is first available to repay the bonds.
4) Also, I’m curious what your total remaining default estimate is for the 15-A structure? Are you factoring into your analysis that as the pool seasons the prepayment rate on the outstanding loans is also accelerating? On our numbers we are currently estimating that there will be a total of 112mm of additional defaults which translates to 100mm of additional losses. The 112mm of defaults is bifurcated between 66mm of defaults from currently delinquent loans and 46mm of defaults on current loans. In order to impair the B tranche of bonds you need to blow through the 107mm of excess collateral, 14.4mm of cash credit enahancement, and the 30mm of excess spread the deal will generate. When you factor in that recoveries are between 10% and 15% to actually impair the bonds defaults would need to be between 168mm and 178mm so that’s 55mm more than I am currently estimating and all of those additional defaults would have to come from the 334mm of current receivables and with 50-60% of delinquencies eventually curing this would mean that in order to get 100mm of defaults from the loans that are current as of July would require that roughly 2/3 of the remaining loans become delinquent. I’d never say, never, but this seems like an extremely remote probability.
Can you also clarify what you mean by the company should have taken an impairment? They currently consolidate the entire securitization on their balance sheet including a GAAP loan loss provision so there is no residual equity tranche being carried per se. Note 8 of the financial statements shows the 2 securitizations as they are carried on the company’s balance sheet for GAAP purposes. They don’t delineate between the 15 and 16 securitizations, but in the aggregate they have 145mm of reserves against the receivables so if you look at the securitizations in the aggregate they have 923mm of receivables against 601mm of bonds which gives you 322mm of what you might equate to the residual, but against this 322mm of equity/residual they are already carrying a reserve of 145mm so arguably they are carrying it at 55% of its face value which would be somewhat equivalent to an impairment.
|Entry||11/03/2016 07:59 PM|
Piggy, has the story changed since you first wrote it up? Is there any news from a third-party source, or any other information you have seen that might have contributed to the decline? Thanks.