PSB Monthly Issue December 2013

Every year we tend to hear about what businesses are poised to thrive off retail spending during the holidays.  And, then there are the companies that are just hanging on, relying on holiday spending to stave off disaster.

Of course, the theme over the last few years has been the shift from shopping at brick-and-mortar stores to online shopping.  Basically, every year the number of online sales grows.

It’s particularly apparent in the retail electronics industry. Circuit City and Ultimate Electronics are gone.  Best Buy (BBY), the last big format electronics store standing, has had to undergo a major transformation just to stay afloat.

Here’s the thing…

90% of retail transactions still take place in brick-and-mortar stores.  That means, there’s still enough opportunity for “old fashioned” electronics stores to survive.

The key is making the experience for the customer worthwhile, as well as making sure there are no frivolous costs involved.

And that’s where RadioShack (NYSE: RSH) comes into the discussion.

THE RETAIL ELECTRONICS BUSINESS

RSH is a well-known, retail consumer electronics chain.  After all, the company’s been around since 1899.  These days RadioShack has 4,600 retail stores in the United States and Mexico.  Plus, it has more than 1,000 dealer outlets and sells its products online.

RSH stores offer a wide variety of electronics products.  Selections include mobile technology products and services, personal and home technology, and power supply needs.  A large part of the company’s business comes from wireless phones and related products.

As you may be aware, RadioShack has struggled in recent years with the rest of the brick-and-mortar electronics industry.  The company hasn’t been able to convince customers to shop at its stores rather than online or elsewhere.  In fact, same store sales have plunged.

However, all hope in not lost.  And, RSH may just be on the verge of making itself relevant again.

Here’s why…

First off, RadioShack is in full turnaround mode under the watchful eye of Joe Magnacca. Magnacca, who become CEO in February of 2013, left Walgreens (WAG) to help right the ship at RSH.

RSH’s turnaround is essentially based on three goals: a better shopping experience, more effective product assortment, and financial stability.

Regarding a better shopping experience, the company has been hard at work rolling out concept stores (with the latest vision of what it wants the customer experience to be).  These new stores have a more hands on experience with products – think Apple store, except with products from all different brands.

So far, the results are compelling.  The new stores are showing sales improvement and same store sales gains.  As such, RSH plans to have over 100 concept stores open by the end of the year.

Moreover, management has been aggressively improving stores’ merchandise assortment.  That is, they’re getting rid of duplicate and unproductive inventory.  If a product is in a store from here on out, then you can bet people are buying it.  Over time, this should help reduce costs and improve inventory turnover.

Finally, in an effort to provide financial stability and flexibility, the company has secured new financing commitments.  With $835 million of financing commitments, RSH can refinance its expensive debt and have enough liquidity to complete the turnaround.

And don’t forget…

RSH made a name for itself by providing a more intimate customer experience than super stores such as Best Buy.  That benefit to consumers still holds true.  The smaller store experience means customers are likely to get a more personalized experience each time they walk in the door.

Now, let’s move on to the finances.

THE NUMBERS

The aggressive turnaround efforts RSH is engaged in aren’t helping the company’s performance in the short-term.  However, the positive impact should be more apparent down the road.

In the meantime, third quarter revenues dropped from $898 million to $805 million year over year.  As I mentioned earlier, the old store format just isn’t working like it used to.  As the company rolls out new concept stores and focuses on productive inventory, revenue numbers should improve.

Operating loss came in at $118 million compared to a loss of $34 million a year ago. Management has stated there would be higher costs associated with the changes in store inventories.  As such, these numbers reflect those increased costs and should lessen over time.

On the bright side, RSH does have a strong balance sheet.  The company has $316 million in cash compared to $499 million in debt.  However, total liquidity (cash available) is as high as $613 million if you include the $296 million in available credit (due to the financing improvements I mentioned earlier).

It doesn’t look like the company will have any liquidity or credit issues while the turnaround is under way.

INVESTMENT RISKS

As with any investment, RSH does have a few risks.

Online competitors could continue to draw away business and make securing new and existing customers more difficult.

An unexpected slowdown in the economy could reduce demand for electronics devices in general and slow the company’s revenue growth.

Finally, changes in interest rates could make the company’s debt holdings more expensive in the future and increase debt servicing costs.

POTENTIAL RETURN OF 100% OR MORE

RSH is in the midst of a major turnaround effort that should pay dividends within the next year.  However, investors aren’t looking very far ahead for this once prominent electronics retailer.

In fact, RSH shares are trading at just 0.07x sales and 0.74x book value.  In comparison, Best Buy (which has also struggled in recent years) is trading at 0.3x sales – nearly 4 times as high as RadioShack shares.

Plus, for a company having reasonable liquidity, any book value under 1.0 is cheap. Not to mention, the company doesn’t have any trouble generating solid operating cash flow.

Based on our analysis, we see RSH climbing to $6.00 a share or more.  Buy the shares now for potential gains of 100% or higher!

ACTION RECOMMENDATION

BUY RadioShack (NYSE: RSH) up to $3.45 per share.

Don’t forget your position sizing and stop-loss rules.