Conn's Inc. Rating: Buy

Transcription

1 HARDLINE/LEISURE Jeffrey Blaeser Company Update August 8, 2007 Key Metrics CONN - NASDAQ $22.35 Pricing Date 08/07/2007 Price Target $ Week Range $32.19-$17.61 Shares Outstanding (mm) 23.4 Market Capitalization ($mm) $ Mo Average Daily Volume 244,303 Institutional Ownership 49% Debt/Total Capital 0.1% ROE 14.3% Book Value/Share $12.49 Price/Book 1.8x Dividend Yield NM EPS($) FY: January Prior Curr. Prior Curr. 2007A 2008E 2008E 2009E 2009E 1Q-Apr A E 2Q-Jul E E 3Q-Oct E E 4Q-Jan E E FY E E P/E 13.5x 11.7x 10.2x Revenue($mm) Prior Curr. Prior Curr. 2007A 2008E 2008E 2009E 2009E 1Q-Apr A E 2Q-Jul E 202.3E E 3Q-Oct E E 4Q-Jan E E FY E 841.7E E 1 Year Price History for CONN Q3 Q1 Q Created by BlueMatrix Company Description: Company Description: Conn's Inc. ( Conn's Inc. operates as a specialty retailer of home appliances and consumer electronics in the United States. It sells appliances, consumer electronics, lawn and garden, furniture, and mattresses. As of April 30, 2007, the company operated 62 retail stores located in Texas and Louisiana. Conn's Inc. was founded in 1890 and is headquartered in Beaumont, Texas Conn's Inc. Rating: Buy CONN's F2Q08 Sales/Comps Above Expectations Investment Highlights: F2Q product sales up Y/Y 9.4% - 5% comp growth. Conn's reported Y/Y F2Q08 product sales growth of 9.4%, exceeding our $176.1mm projection. Sales growth was generated by 5% comparable store sales gains, versus our 2% estimate, and six new store openings Y/Y. The reported sales numbers do not include revenues from finance charges/other, which will be reported in the earnings release scheduled for August 30, Electronics lead the way with 15% Y/Y growth. A majority of the sales growth was generated from electronics sales, which expanded 15% Y/Y to $53.4mm. Lawn/Garden and furniture both increased Y/Y over 30% but reflect a smaller overall sales base (roughly 10% of total product sales) and home appliance and track sales improved modestly in the low single digits. No major surprises within product category growth as all categories were (relatively) within expectations. Easier back-half comparable should provide base for sustainable comp gains. Despite relatively challenging comparable results (F1Q07 comps up 16% and F2Q07 up 7%), first half comps increased Y/Y 2.1% and future results should benefit from easier comparisons going forward (F3Q07 comps down 4% and F4Q07 down 2%) and could provide upside to our 5% comp projection going forward. Strict credit requirements and large down payments should mitigate credit concerns. Before approving financing and determining terms, Conn's performs a strict credit check that has typically kept write-off rates at 3% or lower. We believe down payments for customers with less than ideal credit ratings, oftentimes 25% of the purchase price, limit sub-prime exposure with write-off, for Conn's, trends improving. In F1Q08, the annualized net charge-off rate of 2.7% declined Y/Y from 3.6%, with 60-day delinquency rates dropping to 6.0% from 6.6%. New bond offering appears on target. Despite industry concerns, we believe Conn's remains on track to complete another bond offering in the late summer or early fall time period. Should the offering fall apart, the company should have sufficient capacity within existing programs and $50mm revolving credit facility to sustain expected receivable growth. Macro concerns overdone - sales/earnings growth should continue - Maintain Buy rating. Macro economic conditions appear to be moving Conn's share price lower. We believe these concerns are overstated and continue to believe Conn's is well positioned for full year double digit sales and EPS gains. Delinquency rates appear in check and comp store sales comparisons get significantly easier over the next three quarters. The Disclosure section may be found on pages 4-5 of this report. The Valuation section may be found on page 4 of this report.

2 Conn's reported fiscal second quarter product sales of $179mm. The results improved Y/Y 9.4% and exceeded our expectations by roughly $3mm. Comparable store sales expanded 5%, versus our 2% estimate, with six new store openings bringing the company's total store base up to 62 units. No stores were opened during the past two quarters and the majority of the new openings, eight projected, are expected to materialize in the third and fourth quarters. Product category growth came roughly in line with expectations as electronics led the way with 15% Y/Y growth. The home appliance and track categories improved modestly with 30% gains generated within the lower base lines, which is roughly 10% of total product sales, furniture and lawn/garden. For the remainder of the year, we expect comparable store sales to continue expanding at a 5% rate with potential upside generated from easier comparable results in last year's F3Q and F4Q, which were down 4% and 2%, respectively. The reported sales numbers do not include revenues from finance charges/other, which will be reported in the earnings release scheduled for August 30, Sub-prime credit concerns are not expected to impact future results Despite sub-prime credit concerns, we continue to expect receivable write-offs to trend in a range of 2.5% to 3.0%. We believe down payments for customers with less than ideal credit ratings, oftentimes 25% of the purchase price, limit sub-prime exposure with recent write-off, for Conn's, trends improving. In F1Q08, the annualized net charge-off rate of 2.7% declined Y/Y from 3.6% with 60-day delinquency rates dropping to 6.0% from 6.6%. Full year write-offs could actually provide a benefit to earnings as last year's results came in above 3% due to disruptions to its credit department following hurricane Katrina and Rita. New bond offerings appear on track Another concern surfacing appears to be Conn's ability to complete another bond offering designed to house sold receivables. We believe Conn's remains on track to add another program and target closure for late summer or early fall. Target buyers appear to be similar to those Conn's has utilized in the past and are comfortable with the performance of the portfolios. The addition of another fixed program would limit the company's exposure to potentially escalating interest rates but is not required to satisfy future growth. The company continues to have availability of over $100mm within existing programs, virtually no debt, and approximately $50mm available within a revolving credit facility. Earnings scheduled for release August 30th: We expect $0.41 and maintain our Buy rating on the shares Second quarter results are expected to be released on August 30th. We expect earnings to improve Y/Y 18% to $0.41 with sales expanding 11%. Gross margins should remain relatively flat sequentially yet improve Y/Y 120 basis points via improved sales leverage and increased comparable finance charge/other revenues. Second-half sales results should benefit from expected back-half loaded unit expansion including eight to ten new openings projected over the next two to three years. Currently trading at 12x our FY08 EPS projection of $1.91, we believe the shares are undervalued and believe the recent pull-back in share price provides an attractive opportunity to buy the shares. 2 MORGAN JOSEPH & CO. INC.

3 Conn's Inc. Income Statement (In Millions, Except Per Share Data) Days in quarter FY Q1 Q2 Q3 Q4 FY Q1 Q2E Q3E Q4E FYE Q1E Q2E Q3E Q4E FYE Quarter end 2006 Apr-06 Jul-06 Oct-06 Jan Apr-07 Jul-07 Oct-07 Jan Apr-08 Jul-08 Oct-08 Jan Sales % Increase 23.7% 21.5% 10.7% 0.6% 3.2% 8.4% 6.8% 11.0% 11.2% 13.4% 10.7% 14.3% 12.6% 12.7% 11.3% 12.7% Cost of Goods Sold As % Sales 64.6% 66.2% 66.5% 64.7% 66.4% 66.0% 65.2% 65.3% 64.8% 66.5% 65.5% 65.0% 65.0% 64.5% 66.2% 65.2% % Increase 26.0% 24.6% 15.6% 1.0% 4.6% 10.8% 5.1% 9.0% 11.3% 13.5% 9.8% 13.9% 12.1% 12.2% 10.8% 12.2% Gross Profit Margin 35.4% 33.8% 33.5% 35.3% 33.6% 34.0% 34.8% 34.7% 35.2% 33.5% 34.5% 35.0% 35.0% 35.5% 33.8% 34.8% % Increase 19.6% 15.8% 2.2% 0.0% 0.4% 4.2% 10.1% 15.0% 11.1% 13.2% 12.3% 14.9% 13.5% 13.7% 12.3% 13.6% SG&A As % Sales 26.1% 24.3% 26.6% 28.6% 24.0% 25.8% 25.2% 27.0% 28.3% 24.0% 26.0% 25.0% 27.0% 28.0% 24.5% 26.0% % Increase 19.5% 17.4% 7.7% 5.4% 0.5% 7.2% 10.7% 12.8% 10.0% 13.1% 11.7% 13.6% 12.6% 11.5% 13.7% 12.8% Provision for bad debt As % Sales 0.3% 0.0% 0.2% 0.3% 0.2% 0.2% 0.3% 0.2% 0.3% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2% 0.2% % Increase -67.8% -96.3% NA 58.9% 9.8% -18.8% NA 28.2% -4.9% -3.3% 39.6% -10.7% 0.0% 0.0% 0.0% -2.9% Operating Profit Margin 9.0% 9.5% 6.7% 6.3% 9.3% 8.0% 9.4% 7.5% 6.6% 9.3% 8.3% 9.8% 7.8% 7.3% 9.1% 8.5% % Increase 29.9% 20.3% -18.0% -20.0% 0.2% -3.7% 6.0% 23.1% 16.6% 13.7% 13.8% 19.1% 17.5% 23.4% 9.2% 16.4% Interest Expense Other Income Pretax Profit Margin 9.0% 9.6% 7.2% 6.4% 9.3% 8.2% 9.9% 7.7% 6.9% 9.5% 8.6% 10.0% 8.0% 7.5% 9.3% 8.7% % Increase 35.5% 24.6% -11.4% -18.5% 0.9% -0.7% 10.6% 18.4% 19.4% 15.2% 15.3% 15.3% 17.0% 22.5% 9.0% 15.0% Taxes(benefit) Rate 35.2% 35.1% 35.0% 35.9% 36.2% 35.6% 36.4% 36.0% 36.0% 36.0% 36.1% 36.0% 36.0% 36.0% 36.0% 36.0% Less Preferred Div. Net Income--Oper Margin 5.8% 6.2% 4.7% 4.1% 6.0% 5.3% 6.3% 4.9% 4.4% 6.1% 5.5% 6.4% 5.1% 4.8% 6.0% 5.6% % Increase 35.1% 24.7% -10.9% -19.2% -1.2% -1.3% 8.3% 16.7% 19.2% 15.7% 14.4% 16.0% 17.0% 22.5% 9.0% 15.2% EPS--Operations % Increase 32.6% 21.7% -12.1% -18.9% -1.3% -1.7% 9.8% 17.8% 19.6% 17.8% 15.2% 16.1% 17.0% 22.5% 9.0% 15.2% Shares Out. Basic Shares Out. Diluted Source: Company reports and Morgan Joseph estimates 3 MORGAN JOSEPH & CO. INC.

4 Required Disclosures Rating and Price Target History for: Conn's Inc. (CONN) as of /26/07 I:Buy:$ Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q Created by BlueMatrix Price Target Our price target is $ Valuation Methodology Our $34 price target represents a 17x multiple on our FTM earnings estimate of $2.00. This multiple falls slightly higher than our projected earnings growth rate of 15%. We believe a slight premium is warranted due to a higher possibility for earnings upside surprises, in our view, due to easier comparable during the second half of the year. Further growth could materialize from more aggressive new store openings and a faster return to historical 9% EBIT margins. Risk Factors Conn's stores are highly concentrated in Texas and Louisiana. Growth outside of Texas may not translate as effectively. Growth predicated upon identifying and successfully opening new stores. Credit facility based off of LIBOR rate. Competing retailers are larger in size and scale. Conn's is dependent upon a select group of suppliers. I, Jeffrey Blaeser, the author of this research report, certify that the views expressed in this report accurately reflect my personal views about the subject securities and issuers, and no part of my compensation was, is, or will be directly or indirectly tied to the specific recommendations or views contained in this research report. Research analyst compensation is dependent, in part, upon investment banking revenues received by Morgan Joseph & Co. Inc. Morgan Joseph & Co. Inc. intends to seek or expects to receive compensation for investment banking services from the subject company within the next three months. 4 MORGAN JOSEPH & CO. INC.

5 Investment Banking Services/Past 12 Mos. Rating Percent Percent BUY [B] HOLD [H] SELL [S] Meaning of Ratings A) Buy means reasonable outperformance relative to the market over months. B) Hold means market-type risk adjusted performance; potential source of funds. C) Sell means expected to underperform the market. Other Disclosures The information contained herein is based upon sources believed to be reliable but is not guaranteed by us and is not considered to be all inclusive. It is not to be construed as an offer or the solicitation of an offer to sell or buy the securities mentioned herein. Morgan Joseph & Co. Inc., its affiliates, shareholders, officers, staff, and/or members of their families, may have a position in the securities mentioned herein, and, before or after your receipt of this report, may make or recommend purchases and/or sales for their own accounts or for the accounts of other customers of the Firm from time to time in the open market or otherwise. Opinions expressed are our present opinions only and are subject to change without notice. Morgan Joseph & Co. Inc. is under no obligation to provide updates to the opinions or information provided herein. Additional information is available upon request. Copyright 2007 by Morgan Joseph & Co. Inc. Morgan Joseph & Co. Inc. 600 Fifth Avenue, 19th Fl New York, NY Tel Fax Sales and Trading New York Tel Fax Pittsford Tel Fax MORGAN JOSEPH & CO. INC.