A Growth Business for Tough Times

09/10/2009 12:08 pm EST

Focus: STOCKS

Vahan Janjigian

Editor, Bottom Line's Money Masters Stock Report

Vahan Janjigian, editor of Forbes Growth Investor, says the business of leasing furniture and appliances actually thrives when the economy is weak.

Aaron’s (NYSE: AAN) is a lease-to-own retailer with 1,613 total locations throughout 47 states and Canada. Its namesake banner includes 1,051 company-owned stores and 543 franchised stores that offer consumer electronics (such as LCD TVs, computers, and appliances) and furniture.

Brand names include Sony, Panasonic, JVC, Dell, HP, LG, Philips, GE, Frigidaire, Maytag, and Simmons. AAN’s operations also include 12 company-owned and seven franchised RIMCO stores that offer wheels, tires, and other automobile accessories.

AAN’s core customers are households earning less than $50,000 per year. The lease-to-own model allows customers to obtain merchandise for a monthly lease payment instead of purchasing it outright. Lease terms typically last about two years, after which ownership shifts to the customer.

The recession has made consumers more cautious about spending money on big-ticket items. In addition, credit card companies have raised interest rates and tightened lending standards. According to the Federal Reserve, total outstanding consumer credit fell $80 billion from its peak in July 2008 to $2.5 trillion in June 2009.

Business has been brisk because AAN’s lease-to-own model does not require cash- or credit-constrained consumers to make large outlays upfront or incur additional debt or long-term obligations. Second-quarter revenues rose 7.8% year over year to $417.3 million, [while] same-store revenues at company-operated locations gained 8.4%. The operating profit margin improved 121 basis points to 10.91% helped by better expense management. Net income jumped 19.2% to $27.8 million or 51 cents per share.

There is no evidence that rising unemployment is negatively affecting business. In fact, second-quarter same-store sales were up 7.9% in Michigan, the state with the highest unemployment rate in the country. AAN also has the flexibility to alter lease terms as conditions warrant. For example, it lowered monthly rates on furniture leases last year in order to ease the burden on existing customers and attract new ones. While this reduced monthly receipts per customer, it also lengthened lease terms from 18 to 24 months.

Despite impressive operating results, the stock has been a poor performer. Investors were hoping for stronger growth and were disappointed when management reduced its full-year revenue estimate by $50 million, to $1.75 billion. Furthermore, while AAN’s business model has benefited from the recession, investors are concerned that it could suffer from both a weaker and a stronger economy. A further deepening of the recession could reduce demand for obvious reasons. Yet a stronger economy could also reduce demand by making the lease-to-own model less attractive than outright purchase.

We believe such fears are overblown since AAN caters to lower-income consumers.

Furthermore, management actually raised full-year earnings guidance by a nickel to $1.95-2.05 per share. Management expects 8.4% revenue growth for the second half of 2009. Per share earnings should rise 16.9%. (The shares closed above $26 Wednesday—Editor.)

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