A Stock Implodes and You’re Long. What Next?

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I awoke on Tuesday morning to awful news. Conn’s (CONN), the rent-to-own business that I’m pretty high on, cratered 30% on its earnings release.

conn's conn stockThis was one of those “Bad Luck Schleprock” moments I’ve experienced before. Wowzy wowzy woo woo, whatever shall I do with these stock losses?

Well, this is the perfect opportunity to talk about what you should do if you wake up one day and find that one of your stocks has cratered, and that you’re deep in the red.

Of course, before we prescribe some medicine, we first must assess why the patient is sick.

Why Conn’s Got Canned

Conn’s is in the rent-to-own sector, along with Rent-A-Center (RCII) and Aaron’s (AAN). It’s a cousin to pawnshops and payday lenders, like First Cash Financial Services (FCFS) and Cash America International (CSH), in that it deals with the nonprime consumer. Since these customers can’t afford expensive things like mattresses, appliances, furniture and electronics, RTOs like Conn’s will allow customers to rent the item on a retail installment contact basis.

So, customers rent an item; if they don’t pay, the item is repossessed.

Sales and revenues are actually spectacular. Revenues were up YOY by 30% on same-store sales that grew 11.7%. (where most retailers beg for mid-single digits). Furniture and mattress sales increased 60%. Gross margins came in just under 41%.

However, one arm of this business is that Conn’s will finance the rental as well, and that’s where the business is having trouble.

The problem is that Conn’s is issuing too much credit to too many customers who are defaulting. Conn’s financing business grew 40% to $1.18 billion. Credit revenues spiked 38%, with the portfolio yield hitting 18%. But provision for bad debts went from $18 million to $39.6 million, more than doubling. The 60-day delinquency rate has been climbing from 8% in April to 9.2% at the end of August.

That’s why CONN stock became one of my big losses.

Knowing this sector pretty well, I think Conn’s has been pushing its financing business way too much. It apparently was offering 0% interest deals, which boosted sales … but they aren’t collecting on those sales. I think Conn’s need to back off, tighten underwriting, and get aggressive with collections.

Conn’s says EPS growth will be 12%-15% on operating EPS of $2.80 to $3. Taking the midpoint of both, fair value is roughly $39. On the low end of both ranges, it’s about $34. Meanwhile, Conn’s trades around $31, so we might have some value here after the stock losses.

As for me … well, I have 500 shares of CONN stock that I bought at $38. So I have an interesting problem.

How to Recover

Your first move in a situation like this is to determine if the company’s overall story has changed.   Here, it doesn’t appear that it has. In the conference call — which you must listen to after such an implosion — management said that the increase in delinquencies was not so much related to its 0% interest offers, but that overall economic issues are at play. People first must pay for gas for their cars, their rent, and make payments on their cars. Then they pay their Conn’s bill.

This jibes with the increasing level of consumer debt the Fed is reporting, high gas prices and the stealth inflation that is much higher than the CPI reports. So while management suggests this higher delinquency rate is the “new normal,” it also claims it is going to tighten underwriting. That will decrease the amazing same-store comps were seeing.

With the overall business intact, I am comfortable doubling down here at $30, which gives me a breakeven of $34.

Had the macro story changed, I would sold out and eaten the loss.

Trading since Tuesday morning suggests there’s a floor here around $29, but I’ll set a stop-loss at $27 for these new shares. I’ll also sell 10 Oct $35 covered calls for whatever I can get to further reduce my breakeven price.

As for December earnings … I will be cautious and hedge my long position in some manner, just in case another implosion awaits.

As of this writing, Lawrence Meyers was long CONN. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at pdlcapital66@gmail.com and follow his tweets at @ichabodscranium.


Article printed from InvestorPlace Media, https://investorplace.com/2014/09/conn-stock-losses/.

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