Upbound Group Stock: Recession Resistant Stock, Initiate At Buy (NASDAQ:UPBD)

Background

Upbound Group (NASDAQ:UPBD), formerly Rent-A-Center, is a leading omnichannel lease-to-own (LTO) provider with operations in the United States, Puerto Rico and Mexico. It serves a large pool of underserved consumers offering them ownership of high quality, durable products under flexible lease purchase plans with no debt obligation. It operates through key brands that include Rent-A-Center, Acimo and Colortyme with over 1,850 stores in the US and additional ~125 stores in Mexico. It also operates hundreds of franchise stores across the nation as well.

The company has delivered a strong 200% plus return significantly outperforming the peer group on the back of its robust operational performance, strong network and omnichannel presence, differentiated tech offering and better underwriting capabilities.

Earnings Corner

UPBD reported revenue declining 12.4% YoY primarily due to a lower lease portfolio value from the Acima Segment which declined 8.6% YoY while merchandise sales revenue decreased 30.0% YoY primarily due to fewer customers electing early payouts at both segments. The decline in revenue was attributed primarily due to lower tax refunds for the year, which significantly surpassed consensus revenue estimates. Rent-a-center (RAC) segment comps were down 6.6% YoY due to a smaller lease portfolio but its same-store lease portfolio ended 1Q -3.2% YoY, an acceleration from -4.7% in 4Q22, which is encouraging. EBITDA increased a stellar 13% YoY at $112 mn driven primarily by the Acima segment on the back of improved gross margin and loss rates. Acima skip/stolen losses were 8.9%, inline compared to 4Q22, but down from 12.6% in 1Q22. RAC segment skip/stolen losses were 4.8% vs. 5.8% in 4Q22 and 3.9% in 1Q22. It reported an EPS of $0.83, an increase of 12% YoY, driven by stronger operating profit and surpassing consensus of $0.66.

Management raised its guidance for the year on better than expected results and now expects EBITDA to be in the range of $395-$435 mn (vs $380-$415 mn earlier) and EPS to be in the range of $2.7-3.2 (vs $2.5-$3.0). It expects GMV to be down mid-high single digits in 2Q23 and flat to up low single digits in 2H23 for Acima while RAC same store sales to be down low-mid single digits, with skip/stolen losses at 4.5% for the year.

Is it “Recession Proof”?

UPBD belongs to the lease-to-own category focusing on underserved customers and is countercyclical where in a tight credit environment it pushes more higher quality borrowers into the LTO channel. Banks’ tightening standards come as an aftermath of high profile back to back bank blowups decreasing their willingness to make loans, which also drastically reduced during the 2008 Great Financial Crisis and during the early months of COVID.

Net Percentage of Domestic Banks reporting willingness to make consumer loans

As seen during the Global Financial Crisis, the company reported strong resilience amidst a credit crunch while also maintaining profitability, having expanded its EBITDA margins by 270 bps in 2010 vs 2007. Skip/ stolen losses improved between 2007 to 2009 from 2.8% to 2.3%.

Operational Performance during 2008 Recession

It’s important to keep in mind that our business has outperformed in previous economic downturns… Rent-A-Center demand continued to hold up relatively well with year-over-year portfolio trends improving sequentially from the fourth quarter of 2022… the portfolio outperformed our expectations.

– Mitch Fadel, CEO, Upbound Group

We believe a consistent trade down from credit tightening as well as higher partner uptake including its recent partnership with Genesis would be beneficial for the LTO industry and Upbound in particular.

Valuation

Upbound currently trades at 9x 2023E earnings, a discount to PROG Holdings (PRG) and its long term average. We believe UPBD with its focus on credit constrained consumers, virtual lease-to-own model and omnichannel presence should warrant a premium. We rate UPBD as Buy with a target price of $36 at 12x PE.

Risks to rating include 1) cannibalization of traditional LTO business i.e. Rent-A-Center by Acima and other virtual LTO providers 2) LTO industry is more prone to stricter regulations 3) higher write-offs and skip/ stolen losses would put a dent on margins

Conclusion

We believe LTO is a major beneficiary during a period of credit tightening as consumers look for an alternative approach with banks wary of giving them a credit. UPBD’s focus on underserved customers, however, towards a relatively higher income range (~$50,000 annually), which bodes well for the company’s positioning. UPBD’s exposure to virtual LTO, Acima, which it acquired in 2020, continues to build on the momentum and its store optimization efforts have helped them to generate sustainable margins. We believe UPBD is at an inflection point driven by increasing penetration of LTO industry along with tightening credit. We initiate it at Buy with target price of $36 at 12x 2023 P/E.