We maintain our Hold on Rent-A-Center (RCII) shares ahead of its second quarter earnings report scheduled for July 29. In the first quarter, Rent-A-Center reported better-than-expected results thanks to its restructuring efforts, but management kept its full-year EPS guidance at $2.17- $2.32.
Rent-A-Center's positive factors include its move into the payday loan business and strategic store closures, which should help improve the operating efficiency and cash flow generation of the largest company in the rent-to-own industry. Rent-A-Center's decision to open payday loan businesses, which offer check cashing, bill payment, and wire transfer services, is already paying off.
Despite the weak consumer spending environment, Rent-A-Center should be able to maintain its operating profit margin. The company's operating margin in 2007 was 10.4%. We expect its operating margin to climb to 10.8% in 2008 and 11.1% in 2009. What's more, the company's business model continues to generate stable cash flow.
Nevertheless, the company's positive factors are offset by negative factors such as high energy costs and difficulties in its core business. Rent-A-Center caters to low income customers, and those customers tend to be affected to a greater degree by higher energy and food costs. This will continue to act as headwind for RCII's results because its customers have less discretionary income to spend in its stores, pressuring the company's ability to meaningfully grow its sales and earnings.
RCII shares are trading at 12.8x our 2008 EPS estimate and 10.9x our 2009 EPS estimate. This valuation appears to be cheap, but we think it is a reasonable valuation that reflects the problems associated with the company's core customer base. Our target price of $25.50 is about 11x our 2009 EPS estimate, which is a slight premium to the company's long-term earnings growth rate.
Read the full analyst report on RCII
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