There are many people who cannot or will not buy a home. Instead, they rent. The same goes for major appliances, computers, furniture and other household items. As a result, a massive industry exists to serve this “rent-to-own” market. It’s popular, profitable and produces lots of cash flow.
If you can believe it, there are almost 3,100 Rent-A-Center (NASDAQ:RCII) stores in the U.S., Canada, Mexico and Puerto Rico, along with 765 kiosks, and an additional 220 franchised stores. So you’re looking at a business with 4,000 locations in North America.
The business model is simple: RCII buys an item, rents it out at a rate that allows it to earn back its cost in a relatively short time, and once that threshold is reached, the rest is pure cash flow. Because the company is well-capitalized, it has the money it needs to open stores, pay overhead, buy the products and then sit back and watch the cash roll in.
It’s very similar to another extremely profitable concept: timeshares. Get a bank to finance the construction of a bunch of units, sell each unit 52 times over, and even get buyers to finance that purchase at a higher rate than you borrow at.
Rent-A-Center enjoyed $286 million in operating cash flow in 2011 and has already generated half that in the first quarter of this year alone. The company used some of that cash flow to pay down debt from $740 million to about $650 million. Of course, RCII needs cash flow to keep buying those products to rent out. Otherwise, Q1 earnings are chugging along, with revenues up 12.5% on strong same-store sales of 7.1%.
The company is also rolling out a smart new product called RAC Acceptance. Say a customer wants a brand-name piece of merchandise, but the retailer denies them financing. Rent-A-Center will step in, purchase that item for the customer and put them on an installment plan. It’s not the best source of collateral around, particularly for commodity items, but it’s better than nothing. The program doubled its revenue this year.
On the downside, higher costs are squeezing margins. Still, this is a cash-flow business, and the company has essentially saturated the market to the point where new stores are not coming on line in any volume. Analysts are looking at 10% annualized growth going forward. The stock trades at 11x estimates, and I think the company’s solid cash flow justifies that slightly inflated multiple.
Rent-A-Center is the kind of operation that fits nicely into a portfolio as a stalwart, and the company has begun to offer a dividend of 1.8%. I think that dividend is going to increase as the years go on, making RCII even more attractive.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.
