Tuesday, August 2, 2011

RadioShack Separates Short-Term From Long-Term Investors

Market participants can be roughly divided into two groups: short-term speculators and long-term investors. Nowhere is this dichotomy more clear than in shares of RadioShack (RSH), which have taken a beating for most of this year.

From a short-term perspective, this company's recent operations look downright awful. EPS is expected to come in some 40% lower than last year, for a number of reasons. Problems with suppliers (a disagreement with T-Mobile has put a crimp in that sales category), supplier policy changes (Sprint toughened-up its upgrade policy for consumers), problems with partners (Sam's Club takes control of RadioShack-operated kiosks) and operational changes (closure of its Chinese manufacturing facility) are all contributing to what will be a sub-par year financially for the firm.

But for long-term investors, many of these problems appear transitory. The company will be shifting to a bigger wireless player in Verizon (from T-Mobile), it has ramped up its kiosk business at Target to replace the Sam's Club loss, and it can now source its private-label products in Asia without the fixed costs associated with having a dedicated facility.

For most of this year, the short-termers have beaten the stock price down. But this has created an opportunity for those who can see past these temporary difficulties. Over the last ten years, RadioShack has averaged earnings of $225 million per year. Today, the company trades at just 7 times that number, despite the fact that its net debt to equity level is under 15%.

Managements, too, can have either a long-term or short-term perspective. RadioShack's management appears to be of the former suasion. The company has shown a willingness to take the short-term hits to profits in order to position the company for a brighter future. Furthermore, management has used the weakness in the price of the shares to buy back shares with a vengeance; the company has 20% fewer shares outstanding than it did at this time last year.

There are those who would extrapolate this year's profit drop indefinitely, on the premise that RadioShack's business model is dead. This would be a mistake. Last year, the company's return on equity was over 20%. Furthermore, the company is poised to take advantage of the growth of smartphones and other mobile devices (e.g. tablets), which are "high-touch, high-service transactions" for many consumers. Furthermore, management believes it has not executed well at attaching its high-margin accessories to mobile product sales; this means there is an opportunity for improvement as management strives to get it right.

Short-term profit drops can be deceiving. A better gauge of what a company can earn in the long-term is provided through the use of several years worth of earnings data. For more on RadioShack, see this article.

Disclosure: Author has a long position in shares of RSH


Iowa said...

What I find amazing sometimes is the perception I personally have at a given company by what I know and understand as a consumer and try and translate into sales for a company. The Shack was one example I've found as a 'written-off' electronics store that does amazingly decent as an ongoing entity, and on top of that, management who make decisions that benefit the shareholder as well as providing what customers want. Cash flows- check, dividend- check, shareholder-friendly management- check, margin of safety in share price- check.

Anonymous said...

I feel that radio shack is a dying business. They are way overpriced, and even with low costs, there is not reason to even go there anymore. I understand the #s and fundamentals are still there, but also taking a page from Peter Lynch. Visits to radio shack hasn't been too great. I found they overpriced things by 3xm and are still low quality items.

So my question to you BK is how would you take this into consideration?

Saj Karsan said...

Hi Anon,

Good question. I tend to put more emphasis in the numbers than on subjective information, but maybe that's a mistake, I don't know.

Surely there must be a reason RadioShack is able to generate those returns though, no? They may not appeal to you as a value shopper, but perhaps they offer certain customers the kind of convenience they can't get elsewhere? frankvoisin.com has a good article discussing this topic.

RadioShack can also take advantage of its distribution network to sell whatever the hot consumer electronics items are. If those items are such that many customers want some expert help (smartphones, tablets etc), there is value there that they can add as well.