Core Business Strong At Aaron's (RNT) Despite Q2 Results

Implications: Investors sold shares of Aaron Rents (RNT) yesterday in response to its Q2 earnings release and conference call. Aaron’s lowered FY 2007 guidance, reported lower than normal same store sales growth for the quarter, and discussed struggles in its new store openings initiative, all of which led to a 12% sell-off in shares of RNT. The market overreacted to the report, as the store-level fundamentals are stronger than ever.

Analysis: Aaron’s management cited new store opening costs as the main factor in lowering earnings guidance. Last year, when they announced a goal of opening 350 stores in the 18 months ending December 2007, many outside observers questioned the rationale of such an aggressive mark. After opening 165 stores in the first 12 months of the initiative, they say they can open 185 in the last 6 months of this year. Franchise and company-owned stores were originally planned to contribute equally to the 350 openings, but the mix first changed to 60% corporate/40% franchise, and now appears more likely to be 70% corporate and 30% franchise. While the company has awarded record numbers of stores to franchisees in recent quarters, those franchisees won’t likely open stores this year. The trend shift from leased in-line stores to free-standing, franchisee owned stores has contributed to the lag in franchise opening timelines.

The market’s reaction to the report was overdone. The Q2 earnings decline was mainly due to the sale of stores in Puerto Rico last year that skewed the comparison. Weak results in the rent to rent division also hurt Q2 earnings, and had to compare against Katrina windfall last year. Earnings for the first half of 2007 were still up 16%. Same store sales more accurately increased by 8%, looking solely at lease revenue of the stores, while net revenue comps were weaker due to an increase in retail prices which led to a decrease in retail sales and early payout revenue. Even if the new store openings goal is not met, the core leasing business in the Sales and Lease Ownership division is strong, and it continues to bring new customers in the door and take market share from Rent A Center (RCII). Revenue from franchise royalties and sales of merchandise to franchisees will continue to increase as the pipeline of franchise stores awarded starts to materialize into actual store openings. Rent A Center’s Q2 earnings report next week will give investors a clearer view of the overall rent to own environment.