This week, Durig Capital looks again at a rent-to-own operator who is making outstanding progress in addressing a growing economic segment of the purchasing population. Rent-A-Center (RAC) is the largest rent-to-own operator in North America. Just shy of releasing its first quarter 2018 results, the company has released a business update.
- Preliminary same store growth in the company’s core US segment of 0.3% over a year ago.
- March same store sales grew by 1.6%, showing the company’s initiatives to improve its topline are beginning to take hold.
- Acceptance Now same store sales grew by 3.3% year over year.
- Since December 31, 2017, RAC has reduced its debt by $75 million.
With new management at the helm, Rent-A-Center is aggressively targeting cost savings as well as debt reduction. The company has identified up to $85 million in cost savings is possible and is taking steps to implement these cost reductions. RAC’s B rated, 29 month bonds provide the income investor with a position in the retail sector with a market leader. These 2020 bonds are currently selling at a discount giving them a yield to maturity of over 8.0%. In light of these factors, Durig Capital has marked these Rent-A-Center bonds for addition to its Fixed Income 2 (FX2) high-yield managed income portfolio, the recent performance of which is displayed below.
Latest Business Update
In early April, RAC released a business update. The company has registered preliminary same store sales growth for Q1 of 0.3 percent over Q1 2017, with March increasing by 1.6 percent. In addition, Acceptance Now same store sales grew 3.3 percent in Q1 2018 over Q1 2017. With these early year gains, RAC has raised it guidance for full year free cash flow from $130 million to $170 million.
Evaluating Strategic Alternatives
Late last year, Rent-A-Center announced that the company had begun the process of evaluating strategic and financial alternatives for shareholders. As of the company’s last business update (April 9, 2018), Rent-A-Center announced that its board of directors and advisors were actively engaged with bidders interested in acquiring the company. In most instances, when a company is acquired, the group that is taking over will often restructure the existing debt. From all signs, it appears as if RAC is tracking towards a company sale. In the event this happens, RAC’s existing bonds will more than likely be cashed out and / or refinanced.
RAC expects to reach a determination during the second quarter 2018. RAC also added that the company will not make any additional comments until a formal agreement has been reached or the board of directors has approved a definitive course of action.
In conjunction with evaluating strategic alternatives for the company, in December 2017, RAC hired AlixPartners to evaluate and make recommendations on cost savings opportunities within the company. As a result of this work, RAC has identified between $65 million and $85 million in annualized cost savings opportunities. The company is anticipating realizing two-thirds of these savings in 2018. On the cusp of this discovery came the announcement in March that the company was reducing headcount by 250 positions, representing 25% of its corporate office workforce at its Plano Texas headquarters. This move alone will drive $28 million in annualized cost savings.
…While Improving the Balance Sheet
While working hard to reduce its ongoing costs, RAC has done a fantastic job continuing to reduce its debt thereby improving its balance sheet. In 2017, RAC was able to reduce its debt by $52.5 million. The company was able to accomplish this even as it had a year-over-year decrease in cash flow from operations. In addition, since December 31, 2017, RAC has reduced debt by an additional $75 million due to a stronger topline.
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. The company operates 2,500 stores in the United States, Canada and Puerto Rico, and approximately 1,300 Acceptance Now kiosks. 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.
According to a report published by the Association of Progressive Rental Organizations in 2016, the $8.5 billion rent-to-own industry in the United States, Mexico and Canada consists of approximately 9,200 stores, serves approximately 4.8 million customers and approximately 83% of rent-to-own customers have household incomes between $15,000 and $50,000 per year. The rent-to-own industry provides customers the opportunity to obtain merchandise they might otherwise be unable to obtain due to insufficient cash resources or a lack of access to credit.
Interest Coverage and Liquidity
Interest coverage is of paramount importance for bondholders as it indicates the issuer’s ability to service its existing debt. For the twelve months ending December 31, 2017, Rent-A-Center had operating income (without the effects of non-cash depreciation and amortization) of $70.8 million. For that same period, interest expense was $45.2 million for an interest coverage ratio of 1.6x
According to the company’s most recent business update, RAC has adequate liquidity levels to meet short-term cash needs, with $60.3million in cash as of 02/21/2018, and an additional $175 million available on a revolving credit facility as of April 9, 2017.
The risk for bondholders twofold. First, will the company end up being acquired by another company. If not, will the company be able to continue to grow its revenues, reduce its debt as well as refinance / address any debt that is coming due. The company is actively in talks with groups that have shown an interest in acquisition, but the board of directors has only said it will make an announcement when and if a deal is reached. Even if the company is not acquired, it looks to be making significant strides in improving its topline along with its cost reductions. With these considerations, the company appears to be improving its financial standing notwithstanding the possibility of a company sale. In light of these developments, the competitive ~8.4% yield-to-maturity on these short-term bonds does appear to outweigh the risks identified.
Mitchell Fadel, Rent-A-Center’s new CEO has stated that his turnaround plan for the company is not dependent on customer growth, but on identifying financial cost savings and efficiencies. The company has already begun to address cost reductions with its most recent steps to reduce headcount. In addition, RAC has done a fantastic job of reducing debt over the past 15 months. In addition to these developments, RAC continues to evaluate strategic alternatives, which may include a company sale. RAC’s short term 2020 bonds, currently selling at a discount and offering an attractive yield to maturity of more than 8.0% provide sound diversification for income seeking clients. Therefore, Durig Capital is adding these to its Fixed Income 2 (FX2) High-Yield Managed Income Portfolio.
Issuer: Rent-A-Center, Inc.
Yield to Maturity: ~8.4%
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Durig Capital provides investors with a specialized, transparent fiduciary service at a very low cost. Our FX2 (Discretionary Management) Portfolio over time has greatly outperformed our FX1 (Non-discretionary) Portfolio, giving significantly higher (at times double) the returns of FX1. Our professional service enables access to a broad spectrum of bond, high yields, and lower price points that are often found in less efficient markets, but not evidenced in many bond services.
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Disclosure: Durig Capital and certain clients may hold positions in Rent-A-Center’s 2020 Bonds.
We track thousands of bond issues and their underlying fundamentals for months, sometimes years, before finding any that achieve or surpass the targeted criteria we have found to be successful. Our main priority is to provide the best opportunities for our clients. Our bond reviews are first distributed to our clients, then published on our website and our free email newsletter, and lastly on the Internet and distributed to thousands of prospective clients and competitive firms. Bond selections may not be published if they have very limited availability or liquidity, or viewed as not being in the best interests of our clients. When high yielding bonds with improving fundamentals are acquired at lower costs, Durig Capital believes that investors will appreciate earning higher incomes with our superior high income, low cost, fiduciary services.
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