Upbound Group, Inc. (UPBD) Earnings Call Transcript & Summary

Good afternoon, everyone, and thanks for joining us today. My name is Jason Haas, and I cover Upbound Group and Retail Hardlines here at Bank of America. And I'm really excited to be joined today by Mitch Fadel, who is the CEO of Upbound Group. So Mitch, thank you again for joining us.

Thanks for the invite. Jason. I appreciate it.

So maybe to get started, I was curious if you talked about why you chose to recently change your name to Upbound Group and how the company will operate differently under this new infrastructure?

Yes. Good question. We're pretty excited about Upbound Group. It's really a holding company name. And the gist of it is, we're a whole lot more than just Rent-A-Center these days. We bought a SEMA a couple of years ago. We're no longer just Rent-A-Center where -- so Upbound Group is a holding company name, but it also is going to eventually be a change in the way we support our segments like Rent-A-Center and Acima through our Centers of Excellence program and presumably some synergies between not having both companies have their own marketing, their own technology departments, their own everything. Now some things you do need within the business. You need product innovation within each company, things like that or within each segment, but not everything has to have their own. So some centers of excellence opportunities to bring down overhead over the next few years, not in our guidance, but something we think is some upside for us over time as long as just being a holding company name so that people realize -- we want people to realize we're a lot more than just Rent-A-Center these days.

That's great. And I know alongside the name announcement, you talked on the last earnings call about potentially launching some new products, there was a new loan products. So can you just talk about what that might look like?

Yes, that's part of it, too. The additional products that wouldn't be under either Rent-A-Center or Acima. And of course, we've got some other companies, a franchise company in Mexico and so forth, but the new products we're looking at, that would be more on the loan product or general purpose credit card side are just that, moving upscale -- up our scale a little bit on being able to provide loans, let's say, within our retail partner business. A lot of our competitors or some of our competitors at least have loans besides lease loan, so they can provide a little more one-stop shopping for retail partners. So we want to be able to do that and have that available for customers who will qualify for it. And then a general purpose credit card, we're -- we've got millions of customers in the database that most lenders with a general purpose credit card, I'm talking $400, $500 credit cards, not talking major credit cards. But we've got millions of customers that would never get one of those credit cards, except we have the data that know how well they pay, and they might have a poor credit score, but we've got data over many years of people paying us. So there is an opportunity there to get a general purpose credit card into people's hands that have never -- would never qualify for one otherwise just because of our data that we have on that customer. And so we're looking at that as a product line, not necessarily doing it ourselves. We think probably partnering with somebody that's in that space is more prudent where we provide our data and then share in, in that venture with someone. So not necessarily off our balance sheet, but just to use our data to do a little more business with the customers that we know are good risk from that standpoint. So those are kind of products we're looking at from a loan or general purpose credit card. Again, looking at partner with someone is our first thought. So not any -- you don't have to worry about big balance sheet concerns or stuff like that, which obviously seems like at this stage, that wouldn't be all that prudent to think about. But there's a lot of companies that are willing to partner with us, again, that database is worth a lot, and we can leverage that to help customers a little more and something they need, whether it's a loan or a general purpose credit card, at very little risk because of the data we have and again through a partnership.

Yes. And you do somewhat uniquely serve that financially constrained customers. So I was curious if you could talk about just what you've seen with that customer's financial health over the past few months or so?

Yes. I think the -- with our customer, really the subprime customer, from our standpoint, what we're seeing in our delinquency numbers and so forth, that it seems like at the subprime level, the brunt of the heavy, heavy inflation, the historically high inflation of last year has -- how do I say it, maybe the worst is over is the way we're thinking about it. They had to adjust -- the subprime customer, our customer has lived check to check most of their lives. Some would say they're in a recession constantly. Of course, they had about 18 months of extra money that will probably never happen again in their life, right as far as the stimulus money and rent deferrals and those kind of things. So it was a good 1.5 years or so or almost 2 years, but kind of back to normal for that consumer, I think that what we think is the good news is that heaviest part of that inflation seems like to be behind us and that, that customer has taken the brunt of it adjusted. Of course, now everything you read and think about is how does that affect in the middle income and upper middle income, and it's starting to have impacted layoffs, right, at the $100,000 year and above jobs, engineering jobs and so forth. So there's still -- I think in the country, there's probably still a lot of grief to deal with in this economy, but our good news is it feels like it's behind us with that customer. It's hit them, the inflation -- the high inflation is there. It's actually coming down a little bit, which is good, but the -- they've already had to adjust to it. And it seems like we got hit first with a sub-prime customer, but maybe getting hit first didn't feel good at the time. But now that it feels like it's a bit behind us and it's a little bit more business as normal. Our delinquency numbers have come down. We're really happy with what has happened, how the consumers adjusted. Some of it's our own tightening of underwriting, but it's also a little bit of the consumer adjusting and -- now if the customer above our normal scale starts to have some pressure from what's going on in the economy. We see that as potential windfall from a trade down standpoint. So it feels like our customers get it first. So we're past that. And now maybe it's all upside from a trade down standpoint from our perspective.

What factors do you think are most important to potentially drive that trade down? Would it be like continued high levels of inflation that drives that trade on customer? Would it be a pickup in unemployment?

Anything that scares the lenders above us enough to tighten up, which is -- which could be unemployment. If unemployment doesn't happen, maybe it's some of the banking crisis stuff. Inflation continuing to hold where it is now rather than going down. But anything that takes those prime and near-prime lenders having them to tighten up. And again, it could be any of those or it could be all of them. But anything that has them tighten up would be our windfall from a trade downstream standpoint. And in 2008, it was unemployment. Maybe now it's the quick increase in interest rates as compared to 2008 or maybe it's the inflation not coming back down fast enough, whatever drives them tightening up is what's going to help us. And again, I just feel like -- and I've done this for a lot of years, as you know, Jason, it just feels like in all the metrics we look at, it's -- there's a little bit of benefit going forward in the fact that subprime customer, we're kind of at a trough. We've already hit bottom, if you will, with that consumer.

Yes, definitely. In terms of -- as we look across your business segments by product category, is there anything that stands out to you in terms of what's better performing versus like what's worst performing across like furniture, mattresses, consumer electronics, et cetera?

Yes. One interesting data piece there is when we think about -- and especially shows in the Acima side where the furnitures, the pull-forward aspect of it was -- is probably bigger, and I talked to a lot of our bigger retail partners out there too, whether to Bob's Discount Furniture, Rooms To Go those kind of companies and Ashley. And we probably all -- and they would admit we probably all underestimated how much the pull forward was in Furniture. We just want to still believe it that there was going to be a couple of years where it was tough because of the pull forward. But furniture had the huge pull forward. So that's under the most pressure now. But the good news is 2023, it will be less of a negative than 2022. Every month we get past the pull forward, the better. And what we've really seen, like on the Acima side, especially Wheel and Tire has been a good performer for us because there was no pull forward. So when you think all the customer is under a lot of pressure, and that's the biggest problem in the world, we look at our wheel and tire business going, yes, but we're up in wheel and tire. So how much is a pull forward versus consumer being under pressure, our own tightening, lack of trade down, all those kind of things. It's like, well, if you look at wheel and tire, you say, -- so as we get past the pull forward, things are actually pretty good, which is mostly in furniture on the pull forward. So pull forward in things like laptop, computers that was a huge category as soon as the pandemic had people working from home, kids having to do school work from home. But they don't -- but it's not like they last 5 years, right? So that pull forward doesn't -- from our standpoint, hasn't been as steep as like furniture that certainly lasts a lot longer and so forth. So wheel and tire's strong. Last fall, the jewelry business was pretty strong during the holiday season. So we're -- it's really the pull forward is a furniture story, and I just think that will ease as we move forward.

I think when we talk about the product categories that you're in, whether it's furniture, consumer electronics, these are generally thought of as like consumer discretionary, but I know for your customers, it tends to be not always a discretionary purchase of something price they need. Can you just talk about that sort of dynamic?

Yes, that's a good point. It's not very discretionary when refrigerator just stops working and you've got $800 in your bank account and $700 worth of bills on the kitchen table. That's not very discretionary of going and getting a refrigerator. So most of it is need based. Certainly, there's some aspirational buying, but a lot of that is driven by the need. So you need a refrigerator, if you come into to one of our stores, and we can get you in a side -- a French door refrigerator instead of a traditional one. And because we have low weekly payments and it's only $5 more for that French door, can we make it aspiration and you can upgrade your refrigerator besides just replacing it, and it's only $5 a week. And so we'll try to upsell the aspiration. And again, the low weekly payments allow us to do that as compared to if you went in to Best Buy and one of the refrigerator is, $800 and the other one is $1,800 and somebody is under -- on a budget is going to be -- you're not going to get that upsell. But if it's $20 a week versus $28 a week, you probably can get the upsell on that French door refrigerator. And then the term is longer and so forth for us. So the aspirational part comes, but mostly, it starts with the need, and then we can drive the aspirational. If somebody comes in for a phone and they just need a base phone, but we can get them the latest Samsung phones for $5 more, it's a pretty easy upsell, but it does get driven by the need in the first place.

As we think about your outlook for 2023, can you just talk about what sort of macro assumptions you factor into the outlook in terms of like economic growth, employment inflation, what the credit environment looks like?

Yes, but just more of the same really. We didn't forecast in any tailwind from trade down and so our midpoint is just kind of business as usual the way it is coming into the year. We didn't forecast them anything getting worse because like I said, we think the worst is over for our customers. They've already adjusted. If we factor in worse for our customer, you'd only -- then you'd factor in trade down coming and you'd probably end up at the same place anyhow. So the windfall will be the way we beat our numbers this year is if the trade down happens. But nothing got worse for our customers. It not like inflation went back to 8% or 12% or something like that. We get trade down because of unemployment at the higher-level jobs, not necessarily for our customer. Service workers and so forth is not where we're going to have an unemployment spike. I think you walk through restaurants or hotels like this one we're sitting in, and they still can't find enough workers, right? So in the layoffs you read about are certainly at the higher-end jobs and engineered jobs and so forth. So I think if the -- we can get trade down without any further impact to the subprime customer. That's what we think there's a pretty good possibility in this year, but we didn't factor it into our guidance.

It sounds like trade down would be probably the biggest potential positive to get you the upside of your guidance. In terms of -- if you think about like the risk of the downside, what sort of scenario or where are the potential risks that would bring you to the lower end?

We were talking about this earlier today, and it's hard for us to see the risk because the subprime customer already had to adjust a year's worth of this high inflation, and it feels like the worst is over. I suppose -- the only answer I have for you as far as worse is if the inflation went back over 10% or something, I suppose we could have -- we could be more at the lower end of our guidance than the midpoint, but it would take something pretty extreme like that. We feel like there's a lot more reward versus risk built into where we are today.

In terms of the guidance for the Rent-A-Center business specifically, it does seem to contemplate skip/stolen is improving through the year and also comps improving through the year. Are you assuming that the consumer gets better at all? Or is this more just a reflection of compares that you're lapping? I know you had tightening last year, so can you just talk about that?

Yes. More of the latter, certainly on the Rent-A-Center side -- in both the Rent-A-Center and the Acima side in our earnings deck a couple of weeks ago, if anybody wants to go back and refer to that, the delinquency trends are in there, and you can see in the delinquency trends, the losses are going to come down. So the delinquency -- there is leading indicators, not just my best guess or some pie in the sky number, the leading indicators are losses are going to come down this year, and that's built into the guidance. It's not the most -- they could come down lower than we built in the guidance. We, of course, didn't build in the most aggressive assumption into the guidance either. But the fact that they're coming down is more based on where the delinquency trends are today. And that's part of -- Jason, that's part of why I say the worst is behind us. And we could take credit for why the delinquency numbers are much, much better because of our tightening and we're the smartest people in the world, and we did all the great tightening. But I think part of it is the tightening, but also part of it is our consumer has adjusted and we're getting paid a lot better than we were when inflation first popped because there were some pretty extreme things that happened. If you think about this customer that struggled and all of a sudden had a whole -- wasn't struggling all of a sudden and then struggling again, maybe struggling at new levels based on food prices and things like that. So I mean there are some pretty quick extremes in there, but like they always have done over the number of years I've dealt with subprime customer, they've adjusted and we're getting paid better too. So I think that's all part of the reason I say that the worse from a subprime customer standpoint, is over.

I ask specific about Rent-A-Center, does that dynamic also apply to Acima?

Yes.

And then also on Acima, I think your guidance now, at least sort of half year calls for skip/stolens in the 9% to 9.5% range. In the past, you've given the 6% to 8% long-term target, you still feel like that's the right longer-term skip/stolen rate?

Yes. I think the 6% to 8%, and we've always talked about that as the virtual business being at 6% to 8%, and they're at 8% now, the virtual business. The legacy acceptance now business drives that up into the 9%, 9.5% range because we account for the losses in the acceptance [indiscernible] of the legacy business the same way Rent-A-Center does because that's -- those were the 2 companies we had. The Acima counts for a little differently, that's where the 6% to 8% comes from. How much you put in depreciation versus how much you end up in losses. So the 6% to 8%, the number we said ever since we bought a Acima, we're back to the top end of that range, thankfully. And so we're already there. The 9% to 9.5% overall is because of that legacy business. And we'll have to get Acima in like the 7% range for the total would be 6% to 8%, but we're kind of already there on the virtual side. In the legacy business, it will be -- hopefully by the end of 2023, it will be all under the Acima umbrella and accounting that way anyhow. So yes, I think 6% to 8% is not only the right number to think about going forward, but we also just realize that in the virtual business, we are already there, at least at the high end.

Can you talk about how that Acima customer differs from the Rent-A-Center customer in terms of like income and demographics?

Yes, I probably can articulate this is because our marketing folks could tell you about the demographics. But simply said, I'd say Rent-A-Centers between -- and I'm looking at anything between 35 and 50 Acima is more like 45 to 60. It's kind of like 35 to 50 that 45 to 60 is how I'd kind of -- so it's a step up. It's a little younger demographic. The demographics aren't as different as -- and those are some pretty big differences, demographics, but they're not as different as the cycle graphics, and the consumer that's okay doing a lease, but they want to do it through a retail store, go to the retail shopping experience versus go into a Rent-A-Center store and have that experience because they're totally different experiences. So -- and we're trying to get that more retail experience to rentacenter.com, and almost 25% of our business now or about 25% of our business is coming through rentacenter.com. So we have more of that retail field versus going to a rent-to-own store, but there's a lot of psychographics in there, even more so than demographics.

Is there a noticeable difference in terms of like their financial health at this point? Or is it not really discernible.

I would say not really discernible.

Got it. I guess sticking with the Acima, can you just talk about what the competitive environment looks like for that virtual business?

Yes. There's -- depends what part of the business we're talking about. When you look at -- when you get into the small regional players, the small mom-and-pop, the 3 and 4 store chains, 5-store chains, there's quite a few options they have, and we're out there with 7 or 8 different competitors. As you get up into the type of companies that large enterprise accounts would deal with based on their balance sheet and so forth, that narrows down to really 2 of us, maybe 3, but primarily just the 2 public companies that have great -- they both have great balance sheets and can handle bigger accounts. So the competition is a little steeper again, when you're trying to sign up a 3-store chain is when you're talking to the big ones, it's really getting pretty much between 2 of us.

Are you seeing greater interest from retailers now that we're going into a little bit more of a challenging macro environment? Or is it still difficult to get some of these retails over the hurdles to at least own?

I think the interest is there. I think we're seeing great interest in having great conversations as we've built the enterprise team, we brought Mike Bagull as we mentioned on our call from Synchrony, we brought him back in August, and he's built the team there. We're getting great interest and we had some pretty good interest before that. I'd say Mike's done a nice job getting even more interest is -- the cycle is long. The IT resources are thin for -- the people were talking about those enterprise accounts. So it's a -- there's interest finding for them to find the resources, get it into the top of the priority list versus the other initiatives and so forth. That's the challenge, and that's why the cycle is so long. But lots of conversations with all the big players, and I'm sure our competition is having the same conversations and we just -- we think we'll win our share as we go forward over the next couple of years, that certainly are we want to win every one. But we think reality is we'll win our share. And we've had some good wins at the regional level like companies like Sleep Outfitters and City Furniture and so forth. And as far as continuing to win on to P.C. Richard -- as far as continuing to win on some of them, we feel real good about the team, the conversations, and we'll just keep working every day, and they report up to me weekly, how they're doing. And it's a big focus, and we'll try to win some of the big ones, but it takes 2 to tango, so to speak, and yes, the IT resources, it's tough in some of these companies. They have so many initiatives going on and where $500 million can be really big account for either one of us that are buying for the business, $500 million worth of extra business isn't necessarily a huge number to some of these. You wonder how you could walk in the door, have $500 million opportunity for somebody and them not sign up tomorrow, right? Which happens when you go to medium-sized companies or like some of the bigger accounts we have today, like a Rooms To Go furniture store or an Ashley Furniture store. So yes, you get their attention. $500 million at some of the larger retailers in the world, the Amazons and the Walmarts of the world don't -- they want to talk about it, but they got a lot of things on their plate. So that makes it a long cycle, but we're just going to keep working it.

Yes, it's always been surprising to me covering retail that more retailers don't tap the opportunity to add [indiscernible], but I know it takes time.

Yes.

In terms of -- can you just talk about how the Acima ecosystem is performing?

Yes, the Acima marketplace, you can go to acima.com and hit shop and go to the Acima marketplace. And we've got some unaffiliated vendors on there like Best Buy and a few others and a few others we're adding just this month. So it's performing well. We had some -- back at the end of 2021, we had some underwriting problems in that business. And -- but we fixed that. It's performing well. It's a big part of our business -- not actually big part. It's a growing part of our business. We're going to continue in 2023 to expand that, add other retailers to the marketplace with a virtual lease pay card. We don't have to have an integration with them. They can just shop right there. And it will be part of our growth in 2023 and also part of when we see the GMV turnaround and have positive numbers in the latter half of the year. Part of it is going to be because the marketplace is doing well. And I'm not saying that we got to grow it a lot to get to those numbers. I'm just saying it's already -- it's already back doing well. We're really doing it online virtual lease pay card, not getting back yet into that -- into the plastic card that's available. We had an awful lot of fraud problems with the actual card being out in the marketplace. But the virtual card is working well. The yields are in line with where we need them to be, and we'll continue to expand that in 2023.

That's great. Maybe jumping back to the Rent-A-Center segment. Curious if you could just talk about -- I know the business is sort of normalizing now, actually, you sort of lap the impacts of stimulus, but just curious how you think about that business in terms of like growth in margins longer term?

Yes. I think the good news is that when you're in a trough year, like we believe 2023 is, and you have, I think, a midpoint, Brendan, our EBITDA margins are like 16% in the rent center business, and that's a pretty good trough year if you can go up from there. And I think you got -- year-over-year when you start talking about 2024 versus 2023, you got some low-hanging fruit. You got about 100 basis points in losses. You've got any -- if in the long term, we can run, we can grow just the level of GDP. If we grow 2.5%, we can -- and we keep expenses at 1.5%, you get some operating leverage. And I think 16%, I would say that's the trough. The high end is 20%. We're not going to see probably ever see 22% and 23%, again, like we did for a few quarters, being stimulus and tremendously low losses with the other dynamic working, almost no losses. But the -- so I think it's between 16% and 20%. And over the next couple of years, we can get closer to 20% than the 16%.

That's great. In terms of -- I know over the years for the Rent-A-Center business, more payments have gone remotely. I think a lot of that was during the pandemic, everything went remotely. So you just talk about like what percentage of payments even just roughly are made remotely? And on the back of that, is there any opportunity to strategically reduce the store base? Maybe just don't need as many stores in that type of environment.

Yes. Good question. I think we're a little over half of our payments getting made on AutoPay now. So a lot of payments are being made digitally, not coming in the store. The stores are still important to us. And of course, I mentioned earlier, 25% come at rentacenter.com, but the stores still do the final mile delivery, final mile return. So the stores are still an integral part of the community and doing the deliveries and the returns or anybody that needs to come into the store. So I don't think the footprint is going to change. We don't see that changing much over the years. We do think because more of the business coming at rentacenter.com and you don't -- more shopping online, even in our stores, you can shop online. You can walk in the store and not look at anything just look at everything on the computer screen. And there's extended aisle. So there's even more on the computer than there would be if you just walked around the store. So because more people are shopping online and even in our stores, they can shop online digitally, we can have less square footage per store. You might have the same amount of inventory flowing through. But if you don't have to unbox because you just -- half your business, you're just doing deliveries. You don't have to have as much showroom display. You keep things in boxes. You don't take up as much room because you stack and so forth. So when you put all -- take all into account, we think the average square footage of say, 4,500 could be in the, what, 3,000 range thing. The 3,000 range. Now you got leases and so forth so that you don't just flip a switch and take 1/3 of your rent down. But over time, as you renew leases and you can move into smaller spaces that are in the same shopping center even or give up part of your space, maybe just divider walls. I think over the next 5 years, you could see -- we could see a reduction in total real estate cost but not a reduction in actual locations.

Great. I have a couple more questions here, but we can also take questions from the audience. So we have a mic, and if anyone has any questions, just raise your hand and we can take it.

Except you, Brendan, you can answer.

But in the meantime, I did have a few more here. So -- on capital allocation, so your leverage ratio, I believe it's currently, what I have here is 2.8x. The long-term target is 1.5%. Is the plan basically to use free cash flow this year to pay down debt?

It's certainly going to be the prior because we've got a very healthy dividend, and we like that. And I think most of our shareholders like that, too. And yes, I think with the excess cash flow beyond that, the paying down debt and getting a little closer to that 1.5 will be more the priority this year. Last year, we bought some stock. Really, the last 2 years, we bought some stock, but in this environment, I think it will probably lean a little more towards debt reduction than with that excess cash flow this year.

And in terms of the order of debt paydown, would that be the ABL first? And then I believe you have seen your notes trading at a discount.

Yes. I mean I don't know off the top of head, if we have anything left on a revolver, but revolver is easiest because you don't give up any liquidity. And we have some payments we have to make on the term loan anyhow, so there'll be a little bit of that. The notes are -- they are trading at a discount, but they're a pretty good rate also. What's a rate, Brendan? 6 and 3s. So I don't think we want to retire any of those in this environment at that rate. So it's probably a revolver first and then term loan that would -- that's what you'd say. But I mean, things can change, and the yields can move different direction on the bonds and could change things, but I think right now, that's the way we're thinking about it. I mean you want to -- I mean look at the rates, you got to look at liquidity and so forth. At some point, you got to pay down something that's at a better rate than you could get today anyhow, just to get the debt down, but we've got a we got to work through all that as the year goes on. And Fahmi and Brendan and the team, Brendan is our Vice President of IR here for those of you who aren't in the room, that I keep asking questions down here in the first row and then of course, Fahmi is our CFO, the -- figure out the best way to do that and bring it to me.

Got it. So I know we covered a lot of ground. Maybe to close us out with the last question. I'm curious what you think is either most understood or most underappreciated about Upbound?

I think our -- what's most misunderstood about right now is that really the risk reward formula where we are now, we're talking about the customer -- the subprime customer really already having to adjust and having been hit first. When you think about the opportunity or the opportunity for the tailwind of trade down and then the hard part of seeing where the risk would be to our numbers this year with a healthy dividend we pay in the meantime, even if the stock price didn't go up, that I think, quite honestly, people are missing the fact that the risk reward relative to the dividend, this is a pretty good opportunity right now. And I think a lot of people are missing that because it's, oh, subprime, I want to avoid that, economy is going to get worse. But we're such a resilient play that okay, the economy gets worse, that probably helps us. It certainly has in the past. I think it -- actually, I'd say it will help us because we've already had the subprime customers get away with this high inflation. So things getting worse that means trade down, and that helps us. So I think that's what's misunderstood. We just get categorized with all the, they're in lending, which we are not really in lending, but get drills in that category. When they're in lending, it's subprime and that doesn't feel very good. But I think when you really get under the covers and you look at the risk reward formula of where we are now and the fact that it's a lease and not a sale, the fact that in past downturns, like 2008, '09, we outperformed and that in 2022, skyrocketing losses in Rent-A-Center, skyrocketing for us was 180 basis points. We didn't like it. [indiscernible] like it especially me being on his butt the whole -- the last 6 months, but when 4% went to 5.8%, it's 100 basis. And that's the worst. That's the -- that was the worst that happen now comes down from there. So when you think about the resiliency of the model and how fast Acima was able to fix the underwriting and bring it right back in line last year, I think it's misunderstood that we got this big problem coming forward, we only see bright skies ahead of us if we get to trade down. If we don't, we still had our numbers this year, but maybe we don't blow them away without the trade down. But even if we don't blow away, then you take into account the dividend and you go, should be -- it's a pretty good story. Of course, I'm biased. So I answer your question.

We tend to agree. So all right. So we'll leave it at that. Thank you again.

Thanks, Jason. Thanks, everybody.