The questionable ‘rent-to-own’ business model has served this company well during the pandemic
Today’s company engages in morally dubious rental practices but is emerging a winner as the K-shaped recovery continues to divide the country.
However, no one can deny this strategy has been making the firm money hand-over-fist during the pandemic. While this company continues to succeed, ratings agencies are pricing in the firm for disaster.
Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.
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As is only becoming clearer about the past year, the pandemic has exacerbated the split between two sides of the economy.
On one side, those with more white collar jobs have been able to work at home safely in this environment from home.
Meanwhile, many of those in the service industry have been forced to work limited hours or have been jobless for over a year.
This split in the K-shaped recovery has also meant spending is down across the board. While those who still have work have money to spend, there are less services available to spend it on.
Consequently, consumer credit numbers have not gotten as bad as it normally would get in recessionary times.
Meanwhile, some people are now more desperate for funds, as those losing out on the recovery cannot spend as much as they would like to.
While these spending trends have hurt many, they have led to great benefits for companies like Rent-A-Center (RCII).
Rent-A-Center allows people with higher credit risk, who are more likely to default, to get access to items such as electronics or other high-ticket items they desire.
More importantly, through Rent-A-Center, these individuals are able to purchase these products for less than full price.
Although the ethics of Rent-A-Center are questionable, as they charge high rates for their services, there is no doubt the business is benefiting from strong tailwinds in an environment like the one we are currently in.
The credit rating agencies seem to be missing the picture for Rent-A-Center.
Specifically, the major rating agencies are still skittish when rating Rent-A-Center’s debt. S&P gives the company a non-investment grade speculative rating BB- rating, with the implied assumption of a 10%+ risk of default over the next five years.
Our Credit Cash Flow Prime (CCFP) analysis is able to get to the heart of the firm’s true credit risk.
In the below chart, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).
As depicted, Rent-A-Center has robust cash flows and massive cash liquidity. Therefore, it should have no issues handling its obligations going forward. On top of this, even if the firm did not have access to this capital, cash flows alone exceed all obligations by a wide margin every year including 2026, when the firm has debt maturities.
Rather than a name in distress, Rent-A-Center is actually a cash flow machine. This is why S&P’s BB- non-investment grade speculative rating, with a 10%+ risk of default expectation does not make sense.
Using the CCFP analysis, Valens rates Rent-A-Center as an investment grade IG3- rating. This rating corresponds with a default rate around 1% within the next five years, a more realistic projection once a holistic understanding of the company’s risk is taken into account.
Ultimately, Uniform Accounting and the Credit Cash Flow Prime analysis highlights the significant tailwinds that are priming the company for long-term success.
SUMMARY and Rent-A-Center, Inc. Tearsheet
As the Uniform Accounting tearsheet for Rent-A-Center, Inc. (RCII:USA) highlights, the Uniform P/E trades at 18.5x, which is below global corporate average valuation levels of 25.2x and its historical average valuations of 21.9x.
Low P/Es require low EPS growth to sustain them. In the case of Rent-A-Center, the company has recently shown a 167% Uniform EPS growth.
Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Rent-A-Center’s Wall Street analyst-driven forecast is a 113% and 14% EPS growth in 2020 and 2021, respectively.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Rent-A-Center’s $57.76 stock price. These are often referred to as market embedded expectations.
Rent-A-Center is being valued as if Uniform earnings will be growing 8% annually over the next three years. What Wall Street analysts expect for Rent-A-Center’s earnings growth is above what the current stock market valuation requires in 2020 and 2021.
Furthermore, the company’s earning power is near the corporate average and cash flows and cash on hand are twice its total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals a low dividend and moderate credit risk.
To conclude, Rent-A-Center’s Uniform earnings growth is above peer averages, and is trading near peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research