Rent-to-own makes a comeback

In this down economy, Aaron's business is looking up.

By Suzanne Kapner, writer

(Fortune Magazine) -- Leasing a TV may sound like the type of scheme cooked up by college students and others suffering from cash-strapped fever. But renting to own ordinary household items is expanding to more mainstream consumers. Just ask the folks at Aaron's, the Atlanta-based company with $1.56 billion in sales that leases new and used appliances and furniture to the credit-unworthy.

Add this retailer, with 1,575 stores, and its competitor Rent-A-Center to the list of companies that do well in a recession. First-quarter earnings at Aaron's (AAN) jumped 57%; sales rose 15%.

Here's how Aaron's model works: Aaron's leases, say, a $1,000 TV to a customer for $99 a month. After 24 months the customer owns the TV for a total of $2,600, including taxes and service charges. If the customer is unable to make monthly payments for any reason, he can cancel the lease with no penalty.

A cheaper way to buy the TV would be at a retailer like Best Buy (BBY, Fortune 500), which might charge $1,500. Aaron's customers, however, don't have the cash to pay upfront and can't get financing, so they end up paying nearly double. About half of Aaron's customers make all their payments and wind up owning the product - the outcome in which Aaron's makes the most money. When merchandise is repossessed, it goes back into stock and is marked accordingly.

To stay profitable, of course, Aaron's must choose its customers wisely. Managers are compensated on the basis of the performance of their store: If a customer walks off with a TV, it impacts their bottom line. That's why reference checks are key for Aaron's, whose typical customer makes less than $50,000 a year. "Sometimes you think, Whoa, I'm not selling that person a $1,000 TV," says David Epright, an Aaron's regional manager. "But just because someone looks bad on paper doesn't mean they're a bad credit risk."

One way Aaron's weeds out deadbeats is the "mama test." When a customer is ready to make a purchase, a store manager confirms the customer's information with three different sources, including one family member. The best reference? Mom. "Nine times out of 10 a mother will tell you the truth," Epright says. "I had a mother tell me her son just got out of jail and didn't have a job yet." (He didn't get the TV.) This approach works: Aaron's says its write-offs for nonrecoverable merchandise hover at about 1.5%.

Despite its size, Aaron's retains the feel of a small business. The company got its start in 1955 when Charlie Loudermilk and a partner borrowed $500 to purchase 300 chairs that they rented out for 10 a day. There is no Aaron. Loudermilk, who remains chairman, chose the name for its pole position in the phone book. His son Robin is CEO. Store managers are encouraged to attend local events with their customers; this way, when someone is out of work, an Aaron's manager has a good chance of hearing about it.

Aaron's business model may be striking the right notes in this cash strapped economy, but after a steep climb (the shares are up 17% since January), some analysts say the stock price needs some breathing room. John Baugh of Stifel Nicolaus lowered his rating to a hold from a buy on April 29, following the company's first quarter earnings report - meaning that he no longer expects the shares to rise by 20% or more over the next 12 months.

But David Magee of SunTrust Robinson Humphrey, one of the few analysts to still rate the stock a buy, says there is more upside. He points to Aaron's 12% rise in sales at stores open at a least a year during the first quarter. "You'd be hard pressed to find another retailer putting up those kinds of gains," he says. Moreover, Aaron's is trading at 14.5 times Magee's 2009 earnings estimates, the low end of its historical range of 14 to 17 times, which, he says, could mean the stock has more room to run.

Ask Mom and other credit checks

Aaron's relies on what Mom would say more than on FICO scores to assess creditworthiness. Here are some other tactics its store managers use.

  • Get to know your customers' friends and family. They make the best references (and could be future customers). One easy way: Go to their church.
  • Understand the nuances of your customers' situation. Do they live alone, or have a roommate? How long have they worked at their current job? How solvent is their employer?
  • Talk to their landlord and their boss. It may sound obvious, but these people know the customer.
  • Interview them about their financial status in private. That way a customer feels freer to talk.
  • Trust your instincts. Aaron's deliverymen can turn their trucks around if they don't like what they see when they get to customers' homes.
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