Conn's Insiders Are Catching A Falling Knife, Should You?
Source: seekingalpha.com/article/2533335-conns-insiders-are-catching-a-falling-knife-should-you?app=1&dr=1
Conn's has declined over 60% YTD.
Insiders have been purchasing stock at current levels.
The company remains profitable and even with the reduced EPS guidance, the company should report a strong FY 2015.
CONN Chart
Down over 60% year-to-date, Conn's (NASDAQ:CONN) in the definition of a falling knife. The company has taken hits from increasing customer credit delinquency from its in-house financing program. The company sells large electronics, appliances and home furniture primarily to customers who wouldn't necessarily qualify for financing at Home Depot (NYSE:HD), Lowe's (NYSE:LOW) or Sears. The unexpected jump of the customer portfolio balance 60+ days delinquent to 8.7%, spooked investors and reminded many of the risks of subprime lending. However, the company has taken steps to correct this problem and more importantly insiders are stepping in at 52-week lows to buy shares.
Insiders Buying
In one of my previous articles, "How To Catch A Falling Knife", I outlined how insider buying activity in a stock at or near its 52-week low is a bullish trend that may represent a good opportunity to pick up a stock that has fallen out of favor with investors. After all, insiders generally know better than analysts when their stock is undervalued or when they see a turnaround in operations and positive developments on the horizon. After Conn's reported FY 2Q15 earnings, the stock dropped 30% on delinquency concerns and reduced EPS guidance. Immediately after this drop, several key insiders stepped in and purchased large amounts of stock.
(here you can find some info about the insiders buying. The chart is a bit messed up, to read it best check out the article on SA seekingalpha.com/article/2533335-conns-insiders-are-catching-a-falling-knife-should-you?app=1&dr=1 )
Date
Insider
Shares
Price per Share
Value
9/3/2014
Thompson, Scott (director)
16,100
$ 30.89
$ 497,329
9/5/2014
Thompson, Scott (director)
10,000
$ 28.74
$ 288,000
9/5/2014
Wright, Theodore (President, CEO)
10,400
$ 28.74
$ 298,896
9/9/2014
Poppe, Michael (COO)
2,000
$ 30.65
$ 61,300
9/10/2014
Schofman, David (director)
1,000
$ 29.95
$ 29,950
Source: OpenInsider
These purchases are major investments and the top management in the company are putting their money where their mouth is and betting big on a turnaround in Conn's. Perhaps even more important than this heavy insider action was Luxor Capital Group, an activist hedge fund that specializes in investing in distressed companies, buying an additional 1.07 million shares, or nearly 3% of the company, on September 26, 2014. Luxor Capital is one of the major shareholders in the company with just over 8% of shares as of June 30, 2014. This additional purchase makes Luxor the largest single shareholder and signals their confidence in a turnaround.
Date
Insider
Shares
Price per Share
Value
9/24/2014
Luxor Capital Group
407,393
$ 27.52
$ 11,212,763
9/26/2014
Luxor Capital Group
312,461
$ 27.56
$ 8,609,910
9/26/2014
Luxor Capital Group
190,897
$ 28.29
$ 5,400,286
9/26/2014
Luxor Capital Group
141,354
$ 28.48
$ 4,026,279
9/26/2014
Luxor Capital Group
21,448
$ 28.62
$ 613,774
Source: OpenInsider
Conn's Path Forward
With the subprime mortgage lending disaster fresh in every investor's mind, Conn's increase in customer delinquency stemming from the company's in-house subprime financing arm was viewed as the next disaster waiting to happen and the stock dropped over 30%. However, the company has been proactive in tightening underwriting standards and revenue continues to grow and margins remain attractive.
Beginning in late 2013, Conn's began improving underwriting standards to cut down on delinquent customers and increase revenues received. The company has fine tuned and continued to increase standards, which will limit the number of customers but also reduce its portfolio of 60+ day delinquent accounts.
October/November 2013
-Raised minimum FICO required to be underwritten in certain markets
- Reduced limits for certain customer segments
-Began declining certain additional customer segments
February/March 2014
-Increased down payment required for certain customer segments
-Raised minimum FICO required to be underwritten in additional markets
-All stores and markets have the same rules
August/September 2014
-Reduced limits for certain customer segments
-Eliminate use of 6-month cash option
-Eliminate use of 12-month cash option for a small segment of customers
The company estimated these new underwriting rules resulted in an 8%-10% reduction in total sales. The additional standards added in August/September are expected to reduce revenue by another 50 basis points. These steps are essential to ensure the company can reduce delinquency while still serving their intended market. For the FY 2Q15, sales to customers with FICO scores below 550 reduced by 55% and no originations with a FICO score below 525 was instituted in March 2014.
(click to enlarge)
Source: Conn's Investor Day
Even with the stricter underwriting standards in place, same store revenue increased 11.7% and consolidated revenues increased 30.4% to $353 million. In addition, gross margins were over 40% and the company believes this trend will continue due to streamlined warehouses. The company plans to open 4 more stores in FY 2015, making the total 18 and has plans for an additional 15 to 18 stores in FY 2016. New stores will focus on markets with existing distribution systems, which should result in gross margins staying above 40%.
Due to the customer portfolio balance 60+ days delinquent increasing to 8.7% in FY 2Q15 and further deterioration in July and August increasing delinquency by 90 basis points over FY 2Q15, the company reduced guidance to $2.80 to $3.00 adjusted EPS. However, at this point the bad news has been factored into the price and the company looks to be extremely undervalued. While the company has faced customer financing issues over the past several months, the company remains profitable and continues to increase revenue and its store footprint.
Valuation
CONN PE Ratio (<a href=
In a market reaching new highs and entering correction territory, it's difficult to find companies that are growing revenue at a decent rate and still have a low P/E. Because of the massive sell-off, Conn's looks undervalued with a P/E of 11.5. If the company hits EPS estimates for FY 2015, the P/E will drop to 10 to 10.7. If the company can correct its financing division and get underwriting standards to acceptable levels, this stock has the potential for a serious bounce-back. With same store sales increasing double-digits and total consolidated revenue up nearly 30% through the first half of the year, a P/E of 17-19 is attainable and consistent with peers and with previous valuation levels. This would result in a 50-70% increase to around $45-$52/share.
Conclusion
Conn's serves a niche market, which is inherently more risky than typical retailers are used to serving. While this has led to strong revenues, it has also backfired with increased customer delinquency. The stock has taken an absolute beating over the past year, but now insiders and activist investors are taking notice of the depressed stock price and believe the company has value at current levels. More stringent standards will result in more moderate revenue growth, but will ultimately lead to healthier fundamentals and profit. It's extremely difficult to catch a falling knife, but recent insider purchases and company actions to correct problems may be signalling a bottom. The stock was up nearly 7% Monday, which shows the stock has support under $30/share giving investors downside protection. At this point, Conn's is a risky pick, but the upside potential is hard to ignore.
AI
