2023-08-18 08:41:33 ET
Summary
- Aaron's has been lagging in growth compared to other lease-to-own providers, Upbound Group and PROG Holdings facing market share loss to virtual LTO.
- It operates in an LTO industry which can have secular tailwinds as credit tightening amidst prolonged macro weakness could force more consumers in the LTO market.
- AAN has been making strategic shifts including store consolidation and the launch of GenNext stores, however, that has not translated into earnings.
- We believe AAN is likely to underperform the overall LTO industry and ascribe a neutral rating.
Investment Thesis
Aaron's ( AAN ) is among the largest brick-and-mortar lease to own (LTO) providers with stores across the US and Canada. Post the spin-off of the virtual LTO Progressive Holdings in 2020 which it acquired in 2014, the company has not been able to meaningfully capitalize on its store presence as it continues to face market share loss from virtual LTO providers and lagging growth compared to its peers. We remain secularly positive on the LTO industry as the current challenging economic backdrop would lead to credit tightening, which would act as a tailwind. AAN has also adopted a store consolidation strategy and through its GenNext stores (230 stores currently and expects to add 40 more in H2) to increase profitability per store (mgmt. estimates EBITDA enhancement of $100 - $120k per store) which forms 29% of total lease revenues as well as driving its ecommerce growth. However, that has only led to a marginal improvement in operating margins as demand side characteristics continue to put a dampener. We believe AAN is likely to continue underperforming the overall LTO industry, however, ascribe a Hold rating at current levels.
Company Overview
Aaron's is a leading omnichannel provider of lease-to-own and retail purchase solutions of appliances, electronics, furniture, and other home goods. It has ~1,300 stores company owned and franchised across the US and Canada through its brands Aaron's, BrandsMart USA, BrandsMart Leasing, and Woodhaven. It offers LTO products primarily to underserved credit customers, with furniture, appliances, and consumer electronics being the biggest contributors.
Earnings Recap
AAN reported a mixed set of Q2 results , with revenues declining 13% YoY below expectations due to lower lease portfolio at the Aaron's business and lower retail sales at BrandsMart. Lease renewal rate came in at 88.2% (down from 88.5%) while lease portfolio declined by 8.5% YoY due to continued macro pressures. BrandsMart sales declined over 21% YoY due to lower traffic as well as consumers trading down and deferring their big-ticket purchases. Gross margins at Aaron's improved 60 bps on the fewer customers exercising the option of early purchases. Adj. EBITDA margins improved 150 bps YoY, driven by improvement in gross margins as well as marginally lower write-offs due to lease decisioning improvements. E-commerce revenue increased over 5% YoY and now represents 18% of the total lease sales. Adj. EPS came in at $0.39 topping analyst expectations on strong EBITDA margins. Despite the improvement, EBITDA margins remain significantly lower and volatile than its peer, Upbound Group ( UPBD ).
Balance sheet position remains relatively better with cash balance of $38 mn, liquidity of $379 mn including undrawn RCF facility of $341 mn and total debt outstanding declining by $30 mn to $186 mn driven by cash generated from operations.
It revised its revenue guidance lower to be between $2.12 - $2.22 bn (from $2.22-$2.25 bn) reflecting lower BrandsMart revenue from an anticipation of $645-675mn previously to $615 - 645mn currently. It reiterated its full year guidance of adj. EBITDA of $150 mn and adj. EPS of $1.2 at mid-point. We remain skeptical of the company's ability to achieve the mid-point of its guidance as the anticipated cost saving and gross margin expansion appear to be elusive amidst a decreasing demand scenario and competition from virtual LTO providers.
Valuation
AAN trades at a forward PE ratio of 10x at a premium compared to UPBD and in line with PRG. We believe the secular story of virtual LTO players grabbing market share remains as witnessed by the relative growth of UPBD's Acima segment. AAN significantly lags long-term revenue and EBITDA CAGR as well as free cash flows compared to its peers with AAN's levered free cash flows declining 3% over the 3-year period vs 6% decline in PRG (as it continues to invest to drive topline growth) while UPBD had a robust 25% growth in its free cash flows.
Note: PRG was spun off in 2020 and hence only 3-year CAGR is meaningful metric.
Despite the shares sinking over 10% since the announcement of its results, we see limited value at current levels and continue to be bullish on UPBD as highlighted in our previous articles . We initiate at Neutral as we believe its BrandsMart will continue to be significantly challenged, while Aaron's has not been able to get the benefit of the trade down.
Risks to Rating
Risks to rating includes:
1) Prolonged economic downturn could lead to continuation and more stringent credit tightening which can push several consumers within LTO model
2) Store consolidation strategy can work better than anticipated, which can lead to higher EBITDA contribution
3) Any improvement in consumer sentiment could lead to more consumers being eligible for traditional credit purchases, which will lead to a slowdown in the LTO industry
Final Thoughts
AAN has been a key player within the LTO industry with a vast expanse of its store network across the US and Canada. It has initiated a store consolidation strategy a few years back as it focuses on fewer, more profitable stores, continually reviewing its real estate footprint. While store consolidation strategy is a step in the right direction, operating margins continue to lag its larger peer, UPBD. We believe the credit conditions would continue to remain tightened which can benefit the LTO industry but remain skeptical on AAN's growth prospects. Initiate at Neutral.
For further details see:
Aaron's Company: Not The LTO You Want To Own