Thursday, January 13, 2011

RadioShack Cash Back

There are currently a number of retailers trading at low P/E's (e.g. below 10) that generate strong returns on equity (ROE). Value investors know that these are the kinds of stocks that generate strong returns over the long term. RadioShack (RSH), a consumer electronics retailer at shopping malls, strip malls and in kiosks, is another example of a retailer that appears to trade at a discount.

Unlike a few other retailers trading at low P/E's and high ROE's, however, RadioShack is no one-year wonder. Over the last business cycle, its operating margin has fallen below 6.9% only once (3.3% in 2006). Through the recent recession, operating margins were strong and stable, at 7.6%, 8.6% and 8.9% for 2008, 2009 and 2010, respectively.

Because of the company's retail successes in recent years, it has been building up its cash balance despite consistent dividends and occasional buybacks. RadioShack has $720 million of cash, which is about one third of its market cap. As such, the higher-ups have decided to buy back a ton of stock. RadioShack spent $300 million last quarter (which is about 15% of the company's current market cap) buying back shares. Seeing as how the company's P/E is about 9 (based on its current market cap divided by the sum of its last four quarters of earnings), further buy backs at these prices could turn out very well for shareholders.

Investors may already have a bias towards certain competitors of RadioShack in the consumer electronics retailing space. For example, hhgregg (HGG) has shown strong revenue and earnings growth over the last several years, making it a favourite among growth investors. At the other end of the spectrum, strong and steady Best Buy (BBY) has attracted the attention of value investors with its low P/E.

But the important thing to realize is that there are enough spoils to go around. Every retailer will have short-term issues that have the potential to affect the stock price (For RadioShack at the moment, for example, that could be iPhone cannibalization and the loss of Sam's Club kiosks.) But the products being created for consumers, from internet and 3-D tvs to tablet computers to smartphones to video gaming innovations will keep this space growing for years to come. As such, all of these financially healthy companies (unlike Circuit City) appear likely to maintain or grow their profits. Therefore, value investors needn't choose between RadioShack and Best Buy; the fact that both are cheap allows investors to lower their risk by diversifying across the two companies. When the negative sentiment towards this industry and these companies abates, value investors will profit no matter which company posts relatively stronger results.

Disclosure: Author has a long position in shares of BBY and RSH

13 comments:

Water Investor said...

RSH also has about as much debt as it does cash. Although I agree that buying stock back at cheap levels is often a good strategy, it appears that RSH has been buying back stock at higher prices and therefore higher PE multiples. They also have $370mln in operating leases that I consider liabilities, thereby driving equity down and valuing the co. at an even higher Price to Book of the current 2.2 x. I agree that you can't complain about profitability. It's a nice little niche retailer.

ak said...

I agree with Water Investor statements, and also I do not understand how Radio Shack is even making money. A lot of their products can easily be purchasable elsewhere or online for cheaper. All the debt, and liabilities scares me.

Chris said...

I think the Onion put it best with its article titled "Even CEO Can't Figure Out How RadioShack Still In Business": http://www.theonion.com/articles/even-ceo-cant-figure-out-how-radioshack-still-in-b,2190/

RadioShack is a company that has floundered for the last ten years. It's revenue and income have slowly declined pretty much every year. The company pays a paltry dividend. It doesn't matter how cheap it's stock is on an earnings basis... the cash it generates seems to be wasted by Management.

Parker Bohn said...

RSH is generating positive returns for its shareholders. Looking at the last few years, I see that since the start of 2007, dividends per share + the increase in equity per share equals a value increase of 6.3% of the current RSH price that has accrued to the investor each year.

However, using the same logic on a stalwart such as JNJ, I get 5.9%.

The extra 0.4% is hardly compensation for investing in a heavily-shorted (over 9% of float is short) dinosaur with no competitive advantages and a dubious long-term outlook.

So a bet on RSH is not a play for a value increase of 6%, but must logically be a bet on significant odds of a turn-around. Personally, unless a firm is selling near liquidation value, betting on a turn-around is outside of my circle of competence. However, I will admit that my intuition as a consumer has me wondering how Radioshack survives competition from other retailers, much less the interet.

Saj Karsan said...

Hi Water,

I agree that leases are liabilities, but they are also assets. Therefore, I'm not sure they should affect a company's book value, just its leverage level.

Hi Parker,

I'm not sure why you think they require a turnaround. They have earned ROE of around or above 20% for the last 3 or 4 years.

Ben said...

Hi Saj,

I got very interested with Kirkland's, another retailer you discussed several weeks ago.

After a careful analysis i decided not to invest because i think leasing is a double-edge sword.

The high ROEs of most retailers are the result of more leverage rather than a competitive advantage or barriers to entry.

And because it's so easy to open new stores with leasing, it doesn't encourage retailers to be cautious in their expansion plans.
Kirkland's in particular had troubles during the last two years and had to close tens of stores to avoid bankruptcy.

RSH has a better history, at least recently. But in markets without barriers to entry things can change very quickly.

Can you share with us your thoughs about leasing and competition in retailing please ?

Saj Karsan said...

Hi Ben,

I agree with you that leasing adds leverage. As such, I capitalize lease obligations and treat them as debt. In so doing, I can compare this more realistic debt level of a company to its earnings and cash flow and equity to understand how serviceable its obligations are, just as I would for any other company. If capitalized lease obligations are too large, I would just stay away, as per this article.

Parker Bohn said...

Hi Saj.

I am a bit slow in responding to your thoughts on RSH, but here are my thoughts in more detail:

RSH appears to have many of the statistical traits of a superior investment: Low P/E, low P/S, low P/CF, high ROE, reasonable balance sheet, and so on.

However, when I look at historical data, I see a stagnant business that has created little wealth for shareholders over the last 10 years.

I'm looking at gurufocus 10 year data. It doesn't include the latest quarter, but that makes little difference.
http://www.gurufocus.com/financials.php?symbol=RSH

As I write this, RSH sells for a total price of $1.6 billion. Over the last 10.75 years, RSH has declared profits of $2.6 billion.

In itself, this looks fine, perhaps even attractive. The problem is in what has happened to those 'profits'. Namely, they have not actually generated much wealth for shareholders.

I do see $372 million in dividends paid over this 10.75 years. Based on the current price, this is a 10.75 year total return of 23%. Unfortunately, this is not enough to keep up with inflation. Also, let's note that the dividend per share has grown slower than inflation (up only 14% in 10.75 years).

So out of $2.6 billion in declared profits, $372 million was distributed as dividends. What happened to the rest? Some of it went into share-buybacks, the rest of it was invested into the business in other ways. In order to account for buy-backs, we'll look at per-share rather than absolute items.

So, how profitable was RSH's investment into their own business?
To me, it looks pretty terrible.

Revenues per share have increased moderately over this time period (up about 35%), essentially keeping up with inflation.

Income per share is flat, which does not even keep up with inflation.

It looks like RSH has somehow spent over $2 billion dollars during the last 10 or so years, and has accomplished nothing.

All the shareholders have gained is a small dividend yield.

Basically, RSH is a declining business, which has deployed large amounts of capital simply to retain its position. This can be seen by looking at their ROE and ROA figures, which while still high, have dramatically declined over 10 years (ROE down from 40% to 20%, ROA down from 14% to 8%).

To conclude --- if the next 10 years for RSH look anything like the last 10 years, then RSH is an unattractive investment at current prices.

Now, I do think the shorts should be terrified by RSH's massive share buy-back plan. However, I'm personally uninterested in a declining business.

Time is the friend of a great business. Time has not been the friend of RSH.

Thanks for blogging! I only agree with you about 70% of the time, but I always enjoy reading.

Saj Karsan said...

Hi Parker,

I'd say 70% is pretty highly correlated in this business!

Regarding RSH, I agree that the ten-year management record is weak. However, there was a major management change in 2006, so I'd encourage you to look at management's actions since then. Capex has been consistently lower than depreciation, poorly performing stores are being closed, there is less leverage, and cash is being returned to shareholders in the form of buybacks at very attractive prices.

I agree that RSH is not a growth business, however, I don't have a problem owning declining businesses if the price is right. In the case of RSH, if it uses its earnings to buy back shares for just 7 more years at this price, I would own the entire company. More likely, the price will go up to stop this from happening.

Surely there is some price at which you would buy, even if you think it hasn't reached that price yet, no?

CHINK said...

Saj -

Any insight into what's happening with their accounts receivables? I noticed that their free cash flow conversion from EBITDA declined dramatically the past couple of years. It seems that this has been driven by a sharp increase in their AR Days. Not sure if this could be a red flag of some sort, any insights you (or others) have would be much appreciated. Keep up the good work!

Saj Karsan said...

Thanks, CHINK!

I think the high A/R is a result of the growth in the levels of mobile phone sales. The receivables are from large, solvent carriers, however, so they should arrive in due course, and appear seasonal.

balans said...

It is now more than a year ago since you posted about RSH. They have come out with some not so good revenue reports since then, but they are also a lot cheaper. So, you still think RSH is a value stock? Are you buying more?

Dan

Saj Karsan said...

Hi Dan,

Yeah I think it's a bargain and have bought more. I've been wrong before though!

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