Aaron’s (AAN) is a consumer goods and electronics sale and lease company.  Aaron’s is the largest consumer goods and electronic leasing company in the U.S. with a market cap of $2 billion; slightly larger than rival Rent-A-Center (RCII) which has a market cap of $1.8 billion. Aaron’s is undergoing a transition with the recent acquisition of online consumer products leaser Progressive Financial.

Aaron’s has not reduced its dividend payments since 1994. The company currently has a dividend yield of just 0.3%. Aaron’s is a Dividend Achiever, as it has increased its dividend payments for 10 or more consecutive years. While Aaron’s is a Dividend Achiever, its negligible yield makes it an unsuitable candidate for investors seeking current income.

Business Overview

Aaron’s operates in 3 segments:  Sales & Lease Ownership, Home Smart, and Progressive.  A revenue breakdown for the company’s most recent quarter by segment is shown below to illustrate the relative importance of each segment to Aaron’s:

• Sales & Lease Ownership: 71% of revenue
• Home Smart: 2% of revenue
• Progressive: 27% of revenue

The Sales & Lease segment is Aaron’s largest by far.  The segment contains both the company’s store operated and franchised Aaron’s stores.  In total, the company owns or franchises 2,017 Aaron’s stores. The stores generate revenue by selling or leasing (with monthly terms) consumer home goods and electronics.

The Home Smart segment was responsible for just 2% of Aaron’s revenue in the third quarter of 2014. The segment consists of 82 company operated stores and 2 franchised locations. The segment differs from the Sales & Lease segment in that it focuses on weekly leases as opposed to monthly leases.

The Progressive segment generated 27% of sales for Aaron’s in its most recent quarter. The segment consists of the recently acquired Progressive Financial company operations. The Progressive segment partners with existing retailers to provide financing for consumer goods purchases.

Competitive Advantage & Growth Prospects

Aaron’s is really two businesses:  a consumer household and electronics goods leasing company with about 2,100 locations, and an online financing company that partners with other retailers to offer leasing arrangements for consumer goods.

The company’s brick and mortar locations are struggling. The company faces fierce competition from competitors including Rent-A-Center which owns about 3,000 stores. (nearly 50% more than Aaron’s). The company saw comparable store sales decline 2.5% in its most recent quarter for company owned stores.  For comparison, Rent-A-Center saw comparable store sales in the U.S. decline 3.5% in its most recent quarter.

The consumer goods leasing business is experiencing headwinds as the U.S. economy continues to strengthen.  As the economy improves, consumers tend to have more cash and credit, with less need to rent their furniture and consumer electronics.  Positive macroeconomic news for the U.S. is negative news for Aaron’s.

On the plus side, the company tends to do well during recessions, as consumers often find themselves in the position to lease their furniture and consumer electronics or do without.  Aaron’s saw its EPS rise nearly 50% from 2007 to 2010, during the Great Recession.  Not only did the company’s operations grow during the Great Recession, but Aaron’s stock price rose as well.  The image below shows Aaron’s performance from the beginning of 2008 to the end of 2009 versus the S&P 500.

Source:  Google Finance

Aaron’s Progressive Financial acquisition has positioned it well for future growth.  Progressive Financial is experiencing rapid growth despite headwinds to the overall leasing industry.  The Progressive segment currently partners with well known retailers including:  Mattress Firm (MFRM), Art Van Furniture, Big Lots (BIG), and Sleepy’s.  The company’s management believes the potential market size for virtual leasing is approximately $24 billion, as the image below shows.

Source:  Aaron’s Investor Relations

Progressive Financial has significantly more partner locations than its smaller peers in the virtual lending category. The company currently partners with about 15,000 locations.  Its nearest competitor, Why Not Lease It, partners with about 5,700 locations.  Aaron’s management expects blistering revenue growth of over 40% for its Progressive segment next year as it partners with new locations.

Aaron’s acquisition of Progressive Financial will drive growth going forward.  If traditional leasing sales are flat, the company will still see double digit revenue growth from its Progressive segment alone. Aaron’s carries about $560 million in debt and is expecting about $250 million in EBITDA for its full fiscal year 2014 for a debt to EBITDA ratio of 2.24.  The company’s relatively conservative financing gives its progressive segment further strength and lending experience.

Valuation

The Progressive division is growing rapidly, but had a pre-tax profit margin of less than 1% for the third quarter of 2014. For the Progressive divisions growth to be valuable, it needs to demonstrate an ability to add substantially to the bottom line. The virtual leasing industry has low barriers to entry (as does the leasing industry in general), and is very competitive as a result.  It will be difficult for Progressive to expand margins in this competitive environment.

Aaron’s has a forward P/E ratio of just 14, making it a solid value for long-term investors. The company does have significant growth prospects ahead. The leasing industry is currently experiencing a downturn do to the improving economy. As a result, Aaron’s stock is up just 6.3% this year, while the market is up 15% over the same time period.

Final Thoughts

Aaron’s has an extremely low dividend yield. The company is experiencing rapid growth in its Progressive division, but this has yet to translate into profits. The company is also currently experiencing negative comparable store sales do to weakness in the leasing industry. On the plus side, Aaron’s stock appears cheap at this time which could attract value investors.

Aaron’s does not qualify for investment using The 8 Rules of Dividend Investing because it does not have a long enough dividend history.  Nevertheless, the company makes an interesting choice for investors looking to hedge against recessions. Aaron’s stock and underlying business has historically done well during recessions as leasing becomes more popular when the economy is in decline. The stock appears cheap at this time as well; investors could see gains from valuation multiple expansion.