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Tickers in this Article: CONN, BBY, HGG
The book "How to Build a Business Warren Buffett Would Buy: The R.C. Willey Story", tells the story of R.C. Willey, an electronics and home furnishings chain based in Utah. The business took off in the 1930s and 1940s when refrigerators, washers and dryers, and other home appliances were first invented. At the time, these items were considered luxury items and the company founder discovered that extending credit to farmers and other customers really helped products fly out of the stores.

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Louisiana-based Conn's (Nasdaq:CONN) employs a similar business model, helping a predominantly blue-collar customer base purchase these items and offering them financing options as well. Accounting implications make the financial reporting a bit difficult to understand, especially compared to retailers that outsource their credit operations, but the model has appeal to customers and potential investors alike. (For more on the "Oracle of Omaha", check out Warren Buffett: How He Does It.)

First Quarter Recap
Total sales advanced 5.8% to $231.3 million on a 3% improvement in retail net sales to $200.1 million, due to strong sales in consumer electronics, furniture and mattresses. Finance-charge revenue grew 12% to account for 13% of total sales. Same-store sales fell 4.6%, which was a less dramatic decline than some of Conn's rivals.

During its own first quarter, hhgregg (NYSE:HGG) witnessed a 6.5% decline in comps while industry titan Best Buy (NYSE:BBY) reported a 4.9% drop in its most recent quarter. Conn's attributed part of the comparable store weakness to the demise of Circuit City, as stores were liquidated and merchandise was sold off at rock-bottom prices. Conn's sees this as a long-term positive - CFO Mike Poppe detailed that Circuit City was a primary competitor with the majority of Conn's store base because of the close vicinity of the locations. Credit Operations
Conn's runs its credit operations in house and relays details on its credit portfolio. Traditionally, at least 60% of sales are made employing its credit options, and all aspects are dealt with internally, including credit checks and payment collections (including passed due payments). In regard to delinquent payments, despite the shaky economy the net charge-off ratio has remained well within historical levels. For the most recent quarter, the ratio was 3%, which was below the 3.6% reported during fiscal 2005 when the economy was humming along. Poppe attributed the low charge-off rates to the ability to closely track its own customers. For instance, Conn's maintains a database on product risk profiles that supports the fact that appliances are more likely to be paid off in full as compared to laptops or other electronics. And, as with a mortgage, a down payment minimizes the risk of default given that the customer has his or her own equity in the product. (For more, see What does it mean when advertisers say that "financing is available"?)

Encouraging Sales
Extending credit to customers can be risky, but Conn's approach has visibility and can actually encourage sales. It leads to repeat customers who are more likely to frequent Conn's over a rival because of Conn's ability to extend credit, determine down payment plans and assist customers in furnishing a home. The accounting implications of running in-house credit operations aren't the most straightforward and resulted in a $1.4 million non-cash fair value increase in Conn's interest in securitized assets, which are created to extend loans to customers. Excluding these fluctuations, first-quarter earnings fell 16% to 47 cents per share. However, this exceeded analyst expectations, and Conn's held its full-year guidance steady at $1.75-1.85 per share.

Bottom Line
At current share prices, Conn's trades at about seven times forward earnings projections. That's quite low on an absolute level and as compared to the rivals listed above. Given earnings guidance, returns on equity will come in at about 12%, which is well above the current industry average, but well below the market's (as measured by the S&P500) average of 20%. Returns on equity should improve along with the economy, which should also help the stock price, but the fact remains that Conn's trades at a discount given its retail and credit business model is not fully understood by many investors. (For more, see Analyzing Retail Stocks.)

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