Conn’s hits reality six months after peak of junk-bond bubble.
When Conn’s – a retailer of furniture, home appliances, and consumer electronics with 91 stores in Texas and surrounding states – announced earnings on Tuesday, its stock crashed 29% premarket and ended the day down 41%. It has lost 73% from its peak a year ago when it still had been a hot miracle retailer that could do no wrong. And the junk bonds it issued six months ago at the very peak of the junk-bond bubble went into “price discovery.”
Turns out, it also finances in-house about 75% of what its customers buy.
And people buy at Conn’s because they can’t buy anywhere else. They’re subprime. They’re the strung-out consumers with bad credit and no cash, the modern American proletariat, the hollowed-out, hard-working middle class whose real wages have declined for years. They’ve been turned down elsewhere. Their credit cards are maxed out, have been cancelled, or are past due. And they walk into Conn’s, and the pressure is on to buy, buy, buy what they can’t afford and didn’t want and may not need. But no problem because Conn’s is going to finance it all.
Selling to these folks and charging for the privilege is one of the most irresistible money makers. It doesn’t matter if they find the same product for a lot less on Amazon because they can’t buy it there. Subprime customers are sitting ducks.
This works wonderfully. Until it’s time to collect….
On September 3, Conn’s had already issued a warning on subprime [Subprime Blows up on Retailer, CEO Warns on ALL Subprime, Hits Auto Sales]. Analysts should have expected the worst. But they didn’t. They still somehow expected a profit of $0.68 per share for this quarter – now obviated by reality, with a vengeance.
When customers don’t have to pay for what they buy, it’s easy to get sales to boom. So third-quarter revenues jumped 19% year-over-year to $370 million. Furniture and mattress sales were up 37% and appliances 25%. Conn’s entered three new markets by opening six new stores. Retail gross margin increased to 40.6%. And the hilariously fictional “adjusted retail segment income” rose nearly 12%.
But there were some hiccups. Its credit segment, drowning in provisions for bad debts, had an operating loss of $33.2 million. Customer accounts receivable balances soared 32.7% year-over-year to $1.25 billion – over one year’s worth of merchandise sales, and nearly four times the amount of all other assets combined. For a company of Conn’s size, this is a huge balance. And they’re rapidly going to heck: 10% were 60+ days delinquent, and provision for bad debts exploded from $22.6 million a year ago to $72.0 million in the third quarter, up 219%!
Conn’s provided an all-around gloomy assessment:
Delinquency increased year-over-year across credit quality levels, customer groups, product categories, geographic regions, and years of origination. Despite tighter underwriting and better collections execution, deterioration in the customer’s ability to resolve delinquency continued throughout the quarter and the expectations for charge-offs over the next 12 months were adjusted to fully reflect this trend.
There would also be “higher expected charge-offs” in the coming year “as losses are occurring at a faster pace than previously anticipated, due to the continued deterioration in the customer’s ability to resolve delinquency.”
In its September 3 warning, Conn’s specifically included America’s most spectacular subprime boom: auto sales. This time around, it didn’t. But subprime is merciless when it strikes back: Despite its hilariously fictional “adjusted retail segment income,” Conn’s had a net loss of $3 million, or $0.08 per share.
It also axed CFO Brian Taylor “effective immediately,” disclosed changes to its management structure, withdrew its guidance for this fiscal year, and said it wouldn’t provide guidance for fiscal 2016.
Moody’s rates Conn’s Ba3, three notches into junk territory, so at the higher end of junk. In June, while the company was still performing miracles and at the very tippy-top of the junk-bond bubble, it sold $250 million of 7.25% senior notes at par, rated B- by S&P and B2 by Moody’s. S&P figured at the time that, in case of default, bondholders might recover only 10% to 30% of their principal.
And this is what happened to these bonds today, just six months later, according to S&P Capital IQ LCD: They fell into “price discovery.”
The harsh secondary market conditions this week are no help, what with price discovery in commodities credits and outflows from the asset class influencing negative sentiment broadly.
Conn’s 7.25% notes due 2022 were quoted sporadically and wide, with bids in the high 60s [that’s 60 cents on the dollar], against offers in the high 70s, according to sources.
They’d been quoted at 86/88 cents on the dollar on Monday before all heck broke loose, and in “the high 90s” prior to the September subprime warning, S&P Capital IQ LCD reported. If a transaction actually took place on Tuesday in the range quoted, these bonds that in June were issued at par would have lost between 25% and 35% of their value in six months.
Conn’s stockholders got hammered down 60% over the same period. When a company defaults, bondholders might get a slice of the remaining pie, while stockholders might end up holding the bag. In this way, junk debt – whether junk bonds or leveraged loans – are joined at the hip to stocks.
Junk debt is cracking, especially at the lower end. Over-indebted companies that have become addicted to ever cheaper money from investors driven to near-insanity by the Fed’s interest rate repression suddenly run out of options. Liquidity dries up, or gets very costly. Expansion plans grind to a halt. Financing subprime customer accounts receivables gets complicated. The cost of capital enters into the equations in a nasty way.
And one of the biggest drivers in the phenomenal multi-year stock market rally, share buybacks? That relentless bid by corporations that has helped push shares to these crazy levels? Much of it was funded by issuing junk debt. And when junk debt swoons, buybacks fizzle. Junk debt doesn’t go down alone. It takes stocks along for the ride.
Even the Treasury Department is worried about junk debt as a threat to the financial system, now that it’s bigger and crappier than it was just prior to the Financial Crisis. And among those who’ll get to eat the losses: unsuspecting retail investors. Read… Treasury Warns Congress (and Investors): This Financial Creature Could Sink the System
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