Shares of popular rent-to-own or lease-to-own (LTO) companies have slumped considerably year to date as investors worry that consumers, especially those at the lower end of the economic ladder, are under pressure from inflation and the end of government stimulus payments. As such, the stocks of Rent-A-Center (RCII -2.70%) and The Aaron's Company (AAN) are down 68% and 53%, respectively. But these businesses should be more resilient than skeptics expect, trade at attractive valuations, and offer strong dividends. Let's take a closer look at Rent-A-Center and Aaron's.
Let's talk about lease-to-own
LTO businesses allow a customer to rent or lease items like home appliances, furniture, or electronics by making multiple payments over time before they eventually own the product, and the companies make money because the total amount paid over the course of the lease is higher than what consumers would have paid if they bought the items outright. These goods are typically leased on a 12- to 24-month basis. Rent-A-Center has over 2,400 locations in North America, including 466 franchised stores and 123 locations in Mexico. Aaron's has over 1,300 locations in North America, with 1,076 of these being company owned and 236 being franchised.
Some critics frown upon the LTO business model because they feel it takes advantage of consumers on the lower end of the economic scale. Customers end up paying more over time for items they lease to own than they would have had they simply purchased the product outright. The other side of the coin is that businesses like Rent-A-Center and Aaron's are filling a void because at this point in time, these consumers don't have many other options for buying big-ticket items like appliances or furniture because they don't have the savings or credit to obtain them in any other way.
For example, Rent-A-Center says that about 40% of U.S. consumers have below-average credit and about half have less than $2,000 in their checking accounts. Aaron's feels that it is providing a necessary service to these consumers and states that its mission is to "enhance people's lives by providing access to high-quality products through affordable lease and retail purchase options." Nearly 75% of Aaron's revenue comes from home appliances and furniture, which are more often purchases that can be classified as "needs" rather than "wants," as people need many of these types of products to go about day-to-day life. Furthermore, because these are purchases made out of necessity as opposed to discretionary buys, Aaron's and Rent-A-Center probably have some insulation against an economic downturn, when discretionary spending declines.
Aaron's and Rent-A-Center can offer a solid value proposition to customers. They offer quick decisions on approvals for leases, fast and even same-day delivery, and flexibility like allowing customers to return an item without penalty if they can't make a payment. These top LTO companies also give customers access to high-quality products from reputable brands that may have otherwise been out of their reach.
Bargain-bin valuations
Investors recognize that consumers, especially those at the lower end of the economic spectrum like Aaron's core customers, likely have less buying power than they did over the last few years because direct government stimulus payments have disappeared and inflation is rising at a nearly double-digit pace. But with a price-to-earnings multiple of 5 and a forward price-to-earnings multiple of just under 5 -- well below the market averages -- I would argue that these concerns are already baked into the stock price. Aaron's also pays out a dividend that yields 3%, which is above the average yield of the S&P 500.
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Rent-A-Center also has an attractive valuation. Shares of Rent-A-Center trade at 16 times earnings but just under four times forward earnings and yield over 6%.
With a large portion of revenue for Aaron's and Rent-A-Center coming from items like home appliances and furniture (for example, furniture and appliances make up 74% of Aaron's revenue), these companies should be able to hold up relatively well in the event of a recessionary environment.
Are the LTO players buys?
There is clearly some risk here, as the market worries that a lack of stimulus spending has diminished the buying power of LTO customers. Aaron's has a more moving parts than Rent-A-Center -- the company is working on integrating a recent acquisition, while also engaging in a strategy to optimize its physical footprint by reducing its store count over the next five years. Aaron's wants to do things like close two existing stores in close proximity to each other and replace them with one revamped store that it says will better serve the market. If this goes according to plan, the company could be in a stronger position by improving capital efficiency, but it could also backfire if customers don't follow Aaron's to its new locations.
I'm willing to predict that Aaron's and Rent-A-Center will hold up well during a recession in the short term, and in the long term, they could grow into better businesses over time if they continue to expand and execute on their strategies. Both companies have grown their online presence in an effort to become omnichannel solutions and reach as many customers as possible. I view both Aaron's and Rent-A-Center as interesting buys for risk-tolerant investors and give an edge to Rent-A-Center based on the fact that Aaron's seems to have more balls in the air; Rent-A-Center's larger footprint, which gives it more scale; and Rent-A-Center's superior dividend.
