Wednesday, January 04, 2006

Rent-A-Way: Rent-to-Own?

Rent-A-Way, Inc. (RWY - $6.40) is one of the nation's largest operators of rental-purchase stores, renting quality name brand merchandise from 792 stores in 34 states. For the fiscal year ended September 30, 2005, payments under rental-purchase contracts for home entertainment products, furniture, personal computers, and major appliances accounted for approximately 34.9%, 29.5%, 17.1%, and 16.1% of the Company’s rental revenues, respectively. The Company also provides prepaid local phone service to consumers on a monthly basis through dPi Teleconnect, LLC., its 83.5%-owned subsidiary.

For fiscal 2005, the Company reported consolidated revenues of $515.9 million, up 2.2% from the prior year. Same store sales increased 2.1 percent. Net income was $8.3 million, or $0.27 per diluted share, versus $7.3 million, or diluted share-net of $0.25, in fiscal 2004.

The rental-purchase business offers an alternative to traditional retail installment sales and generally serves customers that have annual household incomes ranging from $20,000 to $40,000. The Association of Progressive Rental Organizations (APRO),the industry’s trade association, estimated that at the end of 2004 the industry comprised approximately 8,300 stores providing 6.9 million products to 2.7 million households. Despite significant fluctuations in the U.S. economy, the APRO estimates that from 1996 to 2004, revenues generated by the industry have consistently increased, with no year in the period reflecting growth less than 3.3 percent.

Rising loan-rates and higher gas prices, coupled with the impact of Hurricanes Katrina and Rita, have dampened investors' enthusiasm for Rent-Way. The stock price of Rent-Way is trending well-below its 200-day MA of $7.75, and is off 36.7% from its June 2005 high of $10.11 per share.

The 10Q Detective has reviewed management's strategies for pursuing growth and greater profitability in FY '06, and we are suspect that operating metrics will improve materially to drive Rent-Way's common stock higher in price.

The Company believes that nominal increases in prices on certain items are feasible and will enhance profitability. Customers may rent either new merchandise or previously rented merchandise. As of September 30, 2005, weekly rentals currently range from $7.99 to $49.99 for home entertainment equipment, from $6.99 to $41.99 for furniture, from $14.99 to $44.99 for personal computers, and from $9.99 to $31.99 for major appliances. Comparative same-store sales is an important growth metric. Despite increasing rental rates on certain products, same-store sales rose only 2.1% year-over-year, attributable to a decrease of 35,000 rental agreements. Perhaps management has under-estimated the pricing sensitivity of its customers. The cost of entering the rental-purchase business is relatively low; and, Rent-A-Center (RCII), Rent-Way's largest industry competitor, is national in scope and has significantly greater financial resources and name recognition than Rent-Way.

Management is planning to open new stores and to operate them profitably. The 10Q Detective doubts that the Company will smoothly execute on this growth strategy. Operating income of the household rental segment is a key metric that management uses to monitor how revenue growth and cost control measures impact profitability. Operating income of the household rental segment was 8.3% of total revenue for FY '05 versus 9.0% of total revenues last fiscal year. This decrease was attributable to the costs associated with the opening of 46 new stores. New stores generally operate at a loss for approximately eight months after opening.

Rent-Way is actively pursuing acquisitions to leverage existing infrastructure. For example, the Company is seeking out strategic acquisitions that fit within its existing geography to simultaneously enhance revenues and maximize profitability. The problem is that Rent-Way is weighed down in debt. Rent-Way has already incurred substantial debt to finance existing growth and has pledged substantially all assets as collateral for this debt. Total debt is 111.7% of shareholder equity, and the Company's times-interest-earned ratio of 1.42x shows that the Company must dedicate a substantial portion of its cash flow from operations to the payment of existing interest on debt. Given existing loan covenants, the Company’s ability to obtain additional financing is limited,too.

Management has said that customer traffic is rebounding, and that 2006 full year rental revenues will increase by 3-4% over 2005. Nonetheless, we would not rush out to buy these shares. SEC filings indicate that Rent-Way has pledged substantially all of its assets as collateral on existing debt. So much for "hidden" value. This is one stock that we would definitely not rent-to-own!

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