This week, we direct our focus to the retail industry, where this rent-to-own operator is making outstanding progress in addressing a growing economic segment of the purchasing population. Rent-A-Center, the largest rent-to-own operator in North America, has been registering superb growth in its Acceptance Now business segment, averaging over 30% growth in that segment for the last three consecutive quarters. The company also boasts exceptional customer retention, with 60% of its customers renting an additional item before ending their original agreement. Over the past few years, Rent-A-Center has also put in place several initiatives to help reduce costs and increase revenues. The cost reduction initiatives are beginning to take hold, with savings ultimately slated to be as much as $60 million annually. Revenue increases have come not only from its Acceptance Now segment, but through product additions, like smartphones, as well as increased online access for potential customers to pre-qualify for Rent-A-Centers products and services.
Diversification is the best way for investors to minimize portfolio risk while aiming to increase returns, and the 69 month 7.62% yield indicated with its currently discounted price of about 87 is over 4 times higher than similar length U.S. Treasury yields. These B+ rated, medium term bonds provide the income investor with a position in the retail sector with a market leader, and in light of these factors, we have marked these Rent-A-Center bonds for addition to our high yield global fixed income portfolios, FX1 and FX2.
About the Issuer
Rent-A-Center is the largest rent-to-own operator in North America. The company offers its customers the opportunity to obtain ownership of high-quality durable products, such as consumer electronics, appliances, computers, furniture and accessories under flexible rental purchase agreements with no long-term obligation. Between 1993 and 2006, the company maintained an aggressive growth strategy in which it opened new stores as well as acquired underperforming rent-to-own stores, growing from 27 stores to over 3,400 stores by 2006. Presently, the company operates 2,803 stores nationwide. As growth opportunities through consolidation and acquisition have become more limited, Rent-A-Center has begun to focus on additional growth strategies, such as acquiring new customers through sources other than its existing store locations as well as securing additional distribution channels for its products and services.
Growth in Rent-to-Own
There has been a recent renaissance in the rent-to-own industry. Economic factors and an increasingly mobile society have given rent-to-own a fresh, updated look. Approximately 100 million customers in the U.S. do not qualify for standard retail financing. Instead of letting them walk out the door, potentially to the nearest brick and mortar rent-to-own store, many retailers are now offering rent-to-own within their stores as well.
Establishing Additional Revenue Channels
As Rent-A-Center’s growth through acquisition and consolidation has slowed, the company has introduced additional avenues for revenue generation, such as its Acceptance Now business segment and the recent addition of smartphones to its product lineup.
Acceptance Now is a company that partners with name brand retailers to provide customers access to the products they want and need but are unable to get from the retail store. Acceptance Now’s process allows consumers to qualify for rent-to-own merchandise because no credit checks are required and only a low monthly payment is needed. Within the Acceptance Now model, the company operates kiosks within various traditional retailers’ locations and offers the rent-to-own transaction to consumers who do not qualify for financing from these retailers. Operating these kiosks gives Rent-A-Center a very dynamic, agile, and efficient revenue model since the only fixed assets for start-up are the kiosk itself and the associated computer equipment. Total financing requirements for a new kiosk location are approximately $350,000, with roughly 80% of that amount relating to the purchase of rental merchandise. A newly opened location is typically profitable on a monthly basis within seven months after opening.
Acceptance Now’s revenues have shown outstanding growth in the last 18 months. For 2014, the segments revenues were 28% higher than 2013, and in the company’s most recently reported Q2 2015 quarterly results, Acceptance Now revenues surged 32.6% year-over-year. In 2014, Acceptance Now contributed over 20% of Rent-A-Centers total consolidated revenues. Additionally, estimates for the market opportunity for Acceptance Now are in the $20 to $22 billion range. (In 2014, Acceptance Now revenues were $644.8 million). This indicates an enormous growth opportunity.
Another recent addition to Rent-A-Center’s revenue sources is the company’s entry into the burgeoning smartphone market. In July 2014, Rent-A-Center began offering leading, name-brand smartphones and no-contract plans on a rent-to-own basis. This offer appeals to cash- and credit-strapped consumers put off by the high upfront cost of acquiring a smartphone, with no credit check, deposit or long-term contract. Phones may be rented in connection with the immediate activation of a no-contract airtime plan, or without. Since its introduction last summer, this segment of Rent-A-Center’s revenue has also begun to gain traction. In Q4 2014, smartphones were over 7% of Core U.S. total store revenues. By Q2 2015, this percentage continued to increase, now accounting for 9% of Core U.S. total store revenues, and contribution margin of this category is approximately 40% and improving.
Engineering Cost Savings, Improving Profitability
In 2013, Rent-A-Center launched several initiatives to transform and modernize its operations in order to improve profitability, including infrastructure initiatives such as developing a new supply chain and innovating its digital e-commerce capabilities. Last year, RAC also implemented a new, more efficient labor model for its Core U.S. stores. The company’s Sourcing and Distribution Initiative is expected to drive $25 to $35 million in annual product cost savings by the end of 2015. To add to this, the company’s new Flexible Labor model will save an additional $20 to $25 million annually by transitioning more employees to part-time status and minimizing overtime wages. Together, these initiatives will drive between $45 and $60 million in annual cost savings.
Rent-A-Center is also investing in e-commerce technologies to improve its customer experiences as well as drive revenues. It has recently introduced the Acceptance Now platform across its third-party retail partner’s websites to provide consumers with pre-approved spending limits prior to their retail visit. Additionally, the company is also piloting a virtual approval engine on its rentacenter.com website. With website traffic up over 30% in 2015, this new offering will help streamline the customer experience, requiring less in-store time to fulfill the customer’s order.
Rent-A-Center’s fastest growing business segment is its Acceptance Now branch. Growth in this segment has been robust over the last three quarters with 28.4% year-over-year growth in Q4 2014, 32.5% in Q1 2015, and 31.6% in Q2 2015.
The company’s consolidated revenues have also shown steady growth, albeit not at the same pace as its Acceptance Now segment. Q4 2014 registered a 4% year-over-year increase, Q1 2015 increased 5.9% and Q2 2015 increased 6.1%. Also, for Q2, the company’s adjusted EBITDA jumped 15% to $75.2 million.
Rent-A-Center’s interest coverage ratio has been consistently in the 4x range. For 2014, the company had operating profit of $193.4 million and interest expense of $47.8 million for interest coverage of 4.0x. In Q2 2015, RAC had operating profit of $49.7 million and interest expense of $12.1 million for interest coverage of 4.1x.
The company has adequate liquidity levels to meet short-term cash needs, with $70.5 million in cash as of 6/30/2015, and an additional $400 million available on a revolving credit facility.
The default risk is Rent-A-Center’s ability to perform. As the company’s business model has matured and expansion opportunities have become limited, it has continued to add revenue sources though its Acceptance Now platform and by adding smartphones to its product offering (an industry first!). These additions, coupled with the cost savings from its Flexible Labor model and Sourcing and Distribution initiative, should increase revenues and decrease costs – a winning combination for any company.
These medium term, 7.6% yielding Rent-A-Center bonds have similar yields and durations to other bond issues reviewed on BondYields.com, such as the 7.83% PHI Inc Bonds, the 8.25% Dynagas Bonds, or the 8.6% Scribe Bonds.
Summary and Conclusion
With rent-to-own transactions on the rise, Rent-A-Center continues to revolutionize the rent-to-own industry through its new programs and products. The company’s Acceptance Now platform continues its outstanding quarterly growth, with more locations slated to be operational by the end of the year. The company was the first rent-to-own operator to offer smartphones to its customers, and this segment continues to provide an even bigger piece of its revenues. These new programs, along with its current cost cutting initiatives staged to provide up to $60 million in annual cost savings, should provide the company with excellent growth prospects moving forward. These medium term, B+ rated bonds, selling at a discount and offering an attractive 7.62% yield to maturity, provide sound diversification for income seeking clients, and we are therefore adding these to our Fixed-Income1.com and Fixed-Income2.com global high yield income portfolios.
Issuer: Rent-A-Center, Inc.
Yield to Maturity: ~7.62%
Disclosure: Some Durig Capital clients may currently own Rent-A-Center’s 2021 bonds.
Please note that all yield and price indications are shown from the time of our research. Our reports are never an offer to buy or sell any security. We are not a broker/dealer, and reports are intended for distribution to our clients. As a result of our institutional association, we frequently obtain better yield/price executions for our clients than is initially indicated in our reports. We welcome inquiries from other advisors that may also be interested in our work and the possibilities of achieving higher yields for retail clients.
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