Dividend Stock Analysis – AAN

[UPDATE 10/22/2014 – This article was just published on SeekingAlpha! Check it out there!]

A couple of days ago, I came across an interesting article about the rent-to-own business. The family profiled in the article calculated that they would be paying $4,158 for a sofa/love seat combo that retailed for about $1,500. Ignoring the whys and hows of what they did, I was fascinated that a company could make this much money off of the situation. I remember living in areas that had these kinds of stores, and they usually did a lot of business, so it’s not like this is a one-time thing. That set me wondering: are these companies as good as they sound, financially speaking? Can they earn a place in my portfolio?

One company that really caught my eye is Aaron’s, Inc (AAN).

Quick Background:

Quoting from the 2013 annual report:

Aaron’s, Inc. is a specialty retailer serving consumers through the sale and lease ownership of furniture, consumer electronics, computers, home appliances, and accessories in over 2,100 Company-operated and franchised stores in the United States and Canada. Aaron’s is the industry leader in serving the moderate-income consumer and offering affordable payment plans, quality merchandise and superior service. The Company’s strategic focus is on growing the sales and lease ownership business through the addition of new Company-operated stores by both internal expansion and acquisitions, as well as through its successful and expanding franchise program.

AAN was founded in 1955 and went public in 1982. It is based in Atlanta, Georgia. AAN’s revenues are varied within the furniture and home furnishing segments: 36% of revenues come from furniture, 29% from electronics, 22% from appliances, 9% from computers, and 4% from miscellaneous items. The company also makes its own furniture through Woodhaven Industries and offers in-house funding for customers via its recent acquisition of Progressive Finance Holdings. Rental fees are collected monthly. The company’s main competitors include Rent-A-Center Inc (RCII), Best Buy (BBY), and Buddy’s Home Furnishings (private).

For more basic information, check out the company’s website and the 2013 annual report.

Fun fact: An investment of $10,000 in December 2000 would be worth $63,573.60 today, all dividends reinvested. This yields a annual rate of return of 14.3%. (Source: FAST Graphs)

Investment Criteria:

So now that we have a basic understanding of who AAN is and what it does, let’s run our basic screening criteria on it, with the help of David Fish’s US Dividend Champions List:

• Pays a dividend: Yes
• Has 5+ years of dividend increases: Yes (11 years)
• Has not frozen dividend for over 8 quarters: Yes
• Has a Chowder number of 12 or more: No (10.1)
• Has am EPS payout ratio of less than 70%: Yes (6.89%)
• Pays a dividend monthly or quarterly: Yes (Quarterly; March, June, August, November)

AAN fails on the Chowder Rule criterion, but passed every other criteria. Let’s use FAST Graphs for the next round of criteria:

• Has an S&P Quality Ranking of ‘A-‘ or better: Yes (A)
• Has generally increasing earnings over the past 10 years: Yes
• Is fairly valued/undervalued according to the Normal P/E ratio (blue line): Yes
• Is fairly valued/undervalued according to the Intrinsic P/E ratio (orange line): Yes

Other Bonus Ratings:

• S&P Capital IQ: Not Rated
  • Scale is 1-5, 1 being ‘strong sell’, 5 being ‘strong buy’
• Thompson Reuters StockReport: 8 (optimized score of 5)
  • Scale is 1-10, 10 being best, 1 being worst
  • Optimized scores weight insider trading and price momentum heavier than other criteria
• Value Line: 3 for safety; 3 for timeliness
  • Scale is 1-5, 1 being best, 5 being worst

Financial Overview:

The dividend yield is terrible at 0.34%, and has an annual payout of $0.08. Perhaps unsurprisingly, it is well covered by free cash flows ($112 million in the past 12 months). With a low payout ratio of 6.89% and a solid cash base, AAN has plenty of room to continue raising its dividend. If the past is any indicator of the future, AAN will grow its dividends at a solid rate. The 10 year dividend growth rate is 19.1%, but has stabilized in the past few years to be in the 12-13% range per annum. There is no reason to expect that management will eliminate its dividend. Management is quoted as saying “[AAN] currently expects to continue its policy of paying dividends” into the future. So despite the fact that the dividend is low, it is encouraging that management takes it seriously. An area of concern is AAN’s debt-to-equity ratio of 0.5. However, AAN’s has aninterest coverage ratio of 15.35, indicating that debt repayment is not an issue, and that the dividend is not under threat. Separately, the stock has had three 3-for-2 stock splits since going public, in 2003, 2004, and 2010.

The P/E ratio is slightly high at 20.09, and Morningstar has a one year forward P/E ratio of 9.7, suggesting massive growth in earnings. Compared to its peer group, AAN’s gross, operating, and net profit margins are all better (84.66% vs 25.83%, 6.09% vs 2.97%, and 3.87% vs 1.89%). However, the company carries more debt and has lower earnings and dividend growth rates. (Source: Scottrade)

For the next five years, it is projected that AAN’s earnings will grow 11.0%, and that the estimated total return will be 15.4%, which is a very solid return as-is. For comparison, RCII’s five year ETR is 16.1% and BBY’s is 13.2%. This hints that AAN will perform in line with or slightly better than its peers in the next few years. (Source: FAST Graphs)

Risk Factors:

Retailers generally have large capital expenditures, and AAN is no exception. Operating cash flow fluctuates heavily depending on the outside economy. Capex doesn’t, hovering around the $60-80 million range. This causes a concerning situation where free cash flow is negative for the year. This happened pre-2007 and in 2010 and 2012. Besides the solid cash flows mentioned above, the company’s cash position per quarter is solid, currently sitting at $231.1 million. The company also has a lot of working capital, $737 million. As a result, although the balance sheet is not amazing, I’m not worried about it either. (Source: Morningstar)

Another area of concern is the overall ethics of the industry. In AAN’s case in particular, the company settled with the FTC over allegations that they knowingly installed spyware on computers they rented out, which collected a lot of personally identifiable and compromising information. The same thing happened again very recently in California, where AAN will pay a $28.4 million fine to resolve the complaints. And going back to the article linked to the first sentence: yes, it’s a good business to charge that kind of money for renting things, but ethically, is it the right thing to do? Well, some investors do not like tobacco or fast food stocks due to ethics, so it’s something to keep in mind when looking at AAN.

One last ‘risk’, if you can call it that, is that AAN is often subject to takeover bids. One major shareholder has bid no less than four times for AAN, most recently in April 2014. Although no one will be investing in AAN just for income, it’s something to keep an eye on. A buyout would be good for capital gains, but your income stream from the stock will be terminated forever.

Some good SeekingAlpha articles on AAN can be found here (bearish compared to RCII), here (bullish), and here (bullish).

Final conclusion:

I believe AAN is an attractive investment, according to my criteria. The only criterion that it fails is the Chowder rule. Surprisingly the Chowder number is higher than expected, given its very low dividend, so the dividend growth is there. The balance sheet isn’t amazing, and will probably be under pressure as long as the economy isn’t growing. Since lower-income people make up a majority of their customer base, AAN won’t do amazingly well until their economic state improves, since they won’t be buying luxuries that AAN focuses on. However, the human need to have ‘nice things’ and keep up appearances is pretty strong, and AAN helps the lower-income group fulfill that need. Hence, I don’t see the rent-to-own industry going away anytime soon. If you can tolerate the low dividend, I’d recommend going long AAN.

What do you think? Does AAN make the cut for your portfolio? Also, how can I improve future analyses?

Disclosure: None.

All data is accurate as of market close, 10/22/2014. My stock analysis archive page has been updated accordingly. Please read my disclaimer here before choosing to invest. Company logo image source is available here. Data source is FAST Graphs or company materials, unless otherwise indicated.

Tags: aan, Aaron's Inc, dividend-stock-analysis