Is Rent-A-Center Doomed or a Value Investment?

Rent-A-Center (NASDAQ: RCII) is one of those companies that is very hard to define. Is it a value investment or a doomed retailer in the death spiral?

Strangely enough, both cases can be made for Rent-A-Center; it has some terrible financial numbers but a business model that at least on paper should generate a lot of float. One thing is certain though: Rent-a-Center is a retailer sitting on very shaky ground that could go down at any time.

For those of you unfamiliar with it, Rent-A-Center operates those rent-to-own locations in low-end shopping malls. There are now around 2,800 in the United States, Canada, Mexico and Puerto Rico. The company also franchises around 227 rent-to-own stores to others.

How Income Inequality Should Boost Rent-A-Center

Over the past decade or so Rent-A-Center has cashed in bigtime on income inequality by renting electronics, appliances, furniture and other times to persons with bad credit. Not surprisingly, that’s a growing business in a nation with an eroding middle class and falling incomes.

The demographics of income in the United States definitely favor Rent-A-Center’s business model. Pew Research reported that the median wealth of middle-class Americans fell by 28% between 2001 and 2013. Income is also falling; the average American household’s income fell from a high of $56,800 in 2000 to $51,939 in 2013, the Economic Policy Institute reported.

This increase is reflected by Rent-A-Center’s revenues, which have been growing steadily for years. Rent-A-Center reported a TTM revenue of $2.882 billion in December 2011 that grew to $3.062 billion a year later, to $3.086 billion in September 2013, to $3.158 billion in December 2014 and to $3.278 billion in December 2015. It looks as if Rent-A-Center’s revenue growth is accelerating.

Americans have less money and more need of Rent-A-Center’s services. The company should be in great shape, yet strangely enough, it is not. Rent a Center’s last earning report seems to paint as gloomy a picture as the bank statements of many of its customers.

Rent-A-Center’s Dismal Earnings Report

Income inequality is definitely increasing Rent-A-Center’s customer base, but it is not helping the company make any money. Instead, its latest earnings report from December 31, 2015, tells a tale of impending disaster.

The dreadful highlights include a net income of -$866.63 million, a diluted earnings per share ratio of -16.34 and a profit margin of -115%. (No, folks, I’m not making this up; its real). To make matters worse, shareholders were punished with a return on equity of -71.19%—meaning they lost 71.19¢ for every dollar they invested.

Nor was Rent-A-Center generating any real cash; it reported a free cash flow of $41.8 million, cash and short-term investments of $60.36 million and $204.14 million in cash from operations for fourth quarter 2015. Those numbers should be higher because the company reported a TTM revenue of $3.278 billion for the same period.

Rent-A-Center’s Incredibly High Dividend

The revenue growth is not translating into increased cash—very much the opposite. One place the cash is going is obvious; Rent-A-Center offered a dividend yield of 7.96%, which seems very high.

This makes the company a great deal like a mortgage real estate investment trust, or MREIT. That is, it attracts investors to a very questionable business by offering a very high dividend. The MREITs famously get people to buy into packages of questionable mortgages and low-end real estate by offering high dividends.

Rent-a Center does much the same thing except the product it is selling is rent-to-own contracts on washing machines, video game systems and easy chairs. This, of course, is a risky business because the company’s only means of forcing payment from its customers is to take back the products.

It is also a very expensive business because Rent-A-Center has to pay manufacturers and suppliers for the goods it rents out. Unlike Home Depot or Best Buy, it cannot buy appliances or electronics on consignment. There are also high operating expenses, such as paying for the trucks and crews that deliver the appliances and furniture when people order it and taking it away when the customers do not pay.

Will Rent-A-Center Collapse?

Add a high dividend to that mix and you get one very unstable business model that is reminiscent of subprime mortgages: purchase goods then sell them to people with little cash and no credit on an installment plan and pay for it by borrowing money at a high interest. Oh, and to make matters worse, there are those franchises based on the same business model.

Not surprisingly, many people will wonder how close Rent-A-Center could be to collapse. That’s hard to say, but it could be closer to collapse than we might think. When economist Richard V. Reeves of the Brookings Institute examined the percentage of income possessed by different classes of Americans, he discovered that the percentage of wealth in the hands of Americans with incomes in the lowest 40% percentile has been steadily falling.

In other words, the poorest Americans with the least income—those most likely to go to Rent-A-Center—have less money with which to repay Rent-A-Center. This might explain some of its troubles; even though its customer base has expanded, those customers have less money and more trouble paying.

It is not clear if Rent-A-Center is doomed. It might be able to adjust its business model to deal with this. However, it is clear that Rent-A-Center could become the next victim of the Retail Apocalypse. Many of its stores, particularly those in states like Colorado and North Dakota, which could suffer through recession, could soon close.

Investors should stay far away from Rent-A-Center because it is such an unstable company. Rent a Center’s business model might no longer be viable, making chances of its survival questionable. Therefore, Rent-A-Center could collapse quickly in the near future.