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Rent-A-Center Inc. (RCII - Analyst Report), one of the largest rent-to-own operators, delivered third-quarter 2012 earnings of 67 cents a share that came in line with the Zacks Consensus Estimate, and increased 11.7% from 60 cents earned in the prior-year quarter, aided by top line growth.

Rent-A-Center’s total revenue, which comprises store and franchise revenues, rose 5% to $739.3 million from the year-ago quarter but fell short of the Zacks Consensus Estimate of $757 million. Comparable-store sales for the quarter rose 1.2%. The increase in the top line was attributable to higher revenue from the RAC Acceptance segment, partly mitigated by a decline in the Core U.S. segment.

The company’s business model, called RAC Acceptance, is gaining traction. When a consumer is denied credit financing for a particular product from the retailer, Rent-A-Center acquires that product from the retailer by virtue of the RAC Acceptance program, and thereby offers it to the consumer under a rental-purchase transaction.

Revenue from the RAC Acceptance business surged 63.4% to $83.8 million from the prior-year quarter, whereas revenue from Core U.S. segment edged down 0.8% to $634.6 million. International segment revenue came in at $10.9 million substantially up from $4.7 million in the year-ago quarter.

Total store revenue rose 4.8% to $729.3 million. The growth was driven by 4.8% advancement in rental and fees revenue to $652.1 million and an 11.5% increase in merchandise sales to $58.9 million, partially offset by a 4.8% decline in installment sales to $15.6 million and 32.2% decrease in other revenue to $2.8 million. Total franchise revenue (ColorTyme segment) climbed 18% to $10 million during the quarter.

We observe that higher cost of revenues kept the gross margin under pressure. Although, Rent-A-Center’s gross profit grew 2.7% to $519.3 million, gross margin shrunk 160 basis points to 70.2%. Cost of rentals and fees rose 11.2% to $158.8 million, whereas cost of merchandise sold grew 10% to $47.5 million.

Operating profit rose 4.2% to $68.1 million, whereas operating profit margin contracted 10 basis points to 9.2%. Adjusted EBITDA climbed 7.5% to $89 million, while adjusted EBITDA margin expanded 30 basis points to 12%.

Stores Update

During the quarter, the company opened 11 new Core U.S. locations, acquired 2 stores and closed 3 stores (2 stores consolidated with existing locations and 1 location closed) bringing the total store count to 2,983. The company also opened 100 RAC Acceptance stores and closed 29 stores (consolidated with existing locations), resulting in 882 stores.

Sixteen international locations were opened and 1 store was shuttered (consolidated with existing locations) during the quarter bringing the count to 114 stores. ColorTyme, which is a wholly owned subsidiary of Rent-A-Center, added 5 new locations and closed 4 stores, taking the total store count to 220. 

For 2012, management plans to open approximately 35 domestic rent-to-own stores. Through the year, the company targets to open 40 rent-to-own locations in Mexico and 6 in Canada. Moreover, the company aims 300 domestic RAC Acceptance kiosk additions.

Other Financial Aspects

Rent-A-Center ended the quarter with cash and cash equivalents of $81.8 million, senior debt of $293.3 million, and shareholders’ equity of $1,460.8 million. During the first-nine months of 2012, the company generated cash flow from operations of about $258.7 million. Management reiterated capital expenditures of approximately $105 million for 2012.

During the first-nine months of 2012, the company bought back 866,985 shares for approximately $30.1 million. Since the inception of the share buyback program, the company has repurchased 30,189,738 shares and has employed approximately $745.6 million out of the $800 million authorized. The company’s Board of Directors enhanced the share repurchase authorization by an additional $200 million to $1 billion.

Strolling Through Guidance

Rent-A-Center projects 2012 top-line growth between 7% and 8.5%, attributable to a low single-digit jump in Core U.S. segment and more than $325 million contribution from the RAC Acceptance business. Management expects comparable-store sales growth of 2% for the fourth quarter and 2012.

Management envisions 2012 earnings in the band of $3.05 to $3.15 per share, including 30 cents cost related to its international expansion initiatives. The current Zacks Consensus Estimate for 2012 is $3.14 that lies near the upper-end of the guidance range. 

Management also forecasted a 175 basis points contraction in gross profit margin for 2012. It also hinted a 50 basis points reduction in operating profit margin for the year.

Closing Comment

Currently, we have a long-term Outperform recommendation on the stock, given its sustained top and bottom lines growth for the past four quarters. However, Rent-A-Center, which competes with Aaron’s Inc. (AAN - Snapshot Report) and Advance America, holds a Zacks #4 Rank that translates into a short-term Sell rating as margins remained under pressure due to higher expenses.

Rent-A-Center offers consumer electronics, appliances and furniture products under rental purchase schemes that allow customers to own the merchandise upon the completion of the rental period. Due to continued tightening of the credit market, customers see rent-to-own as a more flexible and viable option compared to credit. However, the sluggish recovery and a fragile job market may make customers reluctant to enter new rental-purchase deals.

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