RCII is a compelling buy at current levels, at a 15% FCF yield on 2017, a crisis-low 7x forward P/E, and a 6% dividend yield, all as $0.61 in EPS power is set to roll on from expense initiatives. RCII is a BUY with a $26 target for 68% upside.
As a former short, I’m surprised to say that RCII is a compelling buy at these levels. Why get involved in RCII now? Simply, the valuation is at lows, estimates are finally achievable, and benefits from cost cutting initiatives are set to materialize. At the current price of $15.50 (the lowest since March 2008), RCII’s valuation is extremely favorable at a 7.2x forward P/E and a 15% FCF yield on 2017. The 7.2x forward P/E is down from 14.1x earlier this year, and is at crisis-low levels that have historically awarded investors for buying the stock. Furthermore, earnings estimates have finally reset lower to achievable levels, with 2016 down -18% to $2.14 since October, and 2017 down -27% to $2.35. Also, estimates have reset lower right as the gross margins is stabilizing and benefits from various cost initiatives are set to roll on over the next year.
In short, investors were too optimistic on the benefits of various company initiatives heading into 2014 (multiple at 14x), and now sentiment has swung to the other extreme (multiple at 7x). These initiatives were the introduction of selling smartphones in the core rent-to-own stores, growth in the third-party RTO kiosk business Acceptance Now, switching more expensive overtime labor for lower cost part time labor, and realizing cost savings from supply chain initiatives. As RCII shows that they can meet or exceed current estimates (should realize $0.61 of EPS upside from the expense initiatives alone), the P/E multiple should re-rate higher to a level in-line with the 3-year average of 10.9x. Assuming the 3-year average P/E, the current fair value of RCII is $23.50 for 56% upside. Moreover, using the 3-year average 10.9x multiple on my above-the-street 2017 estimate of $2.40, I reach a $26 price target for 68% upside.
Previous Appearances in VIC
RCII has been written up as a long in VIC five times before, most recently in August of 2012 by member Rightlanedriver, and I highly suggest you read his report for a thorough description of each of their business segments. To get a sense of the thought process involved in these previous recommendations, I briefly summarize them here:
8/24/12- Long at $36 by Rightlanedriver, $52.50 target- Paying for the core business and getting the RAC Acceptance business (now called Acceptance Now) and the international business for free. Aggressive growth in the third-party retail business, RAC Acceptance, should lead to an additional $170m in EBITDA (+43%) and $100m in unlevered FCF (+50%) by 2017.
10/4/07- Long at $17.33 by jim211, $26-30 target- Misperceived as a subprime lender, customers healthier than thought as they don’t typically have mortgages, solid $2 in earnings power, and cheap at 8.5x P/E for a market leader.
11/6/05- Long at $18.82 by bal602, no target- Trading at a large relative discount, EPS estimates look conservative, margins should improve with top line growth and cost cutting measures, and potential upside from new opportunities in the financial services business aren’t priced into the stock (payday lending, bill payment and money transfer).
12/8/04- Long at $24.90 by bode314, $40 target- Company has a dominant market position, consistent operating history, and generates enough cash for significant payouts to shareholders. It’s a good business that is struggling with same-store sales growth, but it’s cheap at an 11x P/E vs 24x for the industry.
8/8/03- Long at $69.30 ($24.99 split adjusted) by delta2delta, $120 target ($48 split adjusted)- Quality growth story selling at a significant discount to peers, growing faster than the retail sector while maintaining cost discipline. They have healthy margins and good cash generation, and the stock is cheap at 14x vs the 8-yr trailing multiple of 18x.
According to the Association of Progressive Rental Organizations (APRO), the REO industry in the US, Mexico and Canada did $8.5b in annual revenue in 2012, and was comprised of 10,100 stores, serving 4.8m customers. The two largest players (RCII and AAN) accounted for 6,800 stores (67%), and the majority of the remaining players had fewer than 50 stores. So despite having experienced significant consolidation, the industry remains highly fragmented. The industry serves customers without sufficient funds to make purchases and that lack access to credit, and 83% of the customer base has an annual household income in the $15,000-50,000 range. Industry revenue has grown at a 6.2% CAGR over the last 7 years, and the market share is split with RCII at 34.3% (RAC RTO and Acceptance Now), AAN at 30.7% (Aaron’s and Progressive), and other competitors at 35.0%.
The industry is highly competitive, as RTO offerings are mostly undifferentiated across industry competitors such as RCII, AAN, Buddy’s, EasyHome, and BestWay. Other sources of competition are traditional retailers offering RTO transactions, and the availability of subprime credit. Competition is based primarily on convenience, store location, product selection and availability, customer service, rental rates and terms.
RCII operates through two primary segments, the core rent-to-own (aka RTO) business (73% of sales in 3Q), and Acceptance Now (25% of sales in 3Q), with Mexico and Franchising representing the remaining 2-3%. At 3Q end, RCII had 4,515 staffed locations and 253 unstaffed locations. In 2014, RCII had ~34.3% market share of an estimated $9b industry, with the next largest competitor being Aaron’s (AAN) with an estimated 30.7% market share.