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Why Conn's Stock Could Surge Higher

- By Robert Stephens, CFA

Home furnishings and electronics retailer Conn's Inc. (CONN) is set to deliver improving financial performance as a result of changes being made to its strategy.

Its margins are expected to increase as a result of an expansion of its product categories. The company is also increasing the size of its store estate, while investing in its distribution capabilities in order to improve efficiency.


Although consumer confidence is weak, the company is forecasted to record double-digit earnings growth over the next couple of years. It is also seeking to manage credit risk more effectively as part of its revised overall strategy.

Having fallen 4% in the last year and underperformed the S&P 500 by 15%, the stock could offer recovery potential.

Product refresh

The retailer is in the process of expanding its product categories as it seeks to further differentiate itself from competitors. As part of this initiative, the company recently added robotic vacuums and gaming systems to its inventory, which performed better than expected. Conn's is also planning to add complementary categories which align with its overall retail strategy and could increase cross-selling opportunities. It plans to begin testing cell phone and flooring products in 2020.

The impact of Conn's expanded product strategy on margins is expected to be positive. For example, in the most recent quarter, its product strategy contributed to a 230-basis point increase in the retail gross margin. Further improvements in the gross margin are expected as the company rolls out a greater number of products. A refreshed marketing campaign also seeks to build customer loyalty, providing the business with increased pricing power.

Upgraded strategy

Conn's revenue growth rate is set to benefit from a continued increase in store numbers. In fiscal 2019, it opened a total of seven new stores, which generated revenue and credit performance that was in line with expectations. In fiscal 2020, it plans to open up to 15 new stores. With only 125 stores across 14 states, there appears to be scope to significantly increase its presence over the long run without cannibalizing existing sales.

As part of its expansion strategy, it will seek to enhance the customer experience through a revised store layout. This features a more efficient sales process that could provide it with a competitive advantage versus sector peers. Alongside its investment in new stores, the company is set to open a new distribution center in Houston. This is expected to improve its logistics efficiencies across its largest market. It will also invest in its IT system to support future growth.

Risks

The operating environment for Conn's could become increasingly challenging in the short term. U.S. consumer confidence has declined in four of the last five months, with sentiment among consumers regarding the 2018 tax overhaul continuing to deteriorate. There has also been mixed economic data in the first quarter of 2019, with volatile retail sales growth and jobs growth numbers.

The company's plans to improve its recovery process may strengthen its position in an uncertain wider retail market. It has made progress in implementing additional recovery partners in the most recent quarter and is on track to collect annual recoveries of over $20 million for fiscal 2020. This would represent a near-doubling of the company's 2017 level of recoveries, which reduces loss rates on allowances for bad debt.

In addition, Conn's is implementing an enhanced credit model across its new stores. This has led to first payment default rates on originations in new stores falling by 20% versus existing stores.

Outlook

In 2020, Conn's is projected to post a 23% increase in earnings per share, followed by 16% growth in 2021. Trading with a price-earnings ratio of 11, the stock offers good value.

Changes to its product line could further enhance its growth rate, while also providing greater differentiation versus rivals. Similarly, increasing store numbers and investment in its distribution capabilities could boost Conn's revenue and margins.

Although consumer confidence is weak, the company is taking steps to ensure it is effectively managing credit risk.

Having underperformed the S&P 500 over the last 12 months, the stock could offer investment potential as Conn's implements its revised strategy.

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This article first appeared on GuruFocus.