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Will RadioShack end up like Circuit City?

July 25th, 2012

15 Comments

Written by

Jae Jun

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Earnings for RadioShack is due out tomorrow (well this morning) so by the time you read this, RSH could have sunk further or rocketed up on earnings surprise. Who knows?

And today, most of the info in this article is going to be old news, but I wanted to write something to reflect my thoughts regardless of how earnings turns out.

I can then let the earnings result or whatever management says on their conference call dictate whether my analysis and reasoning was objective and reasonable, and hopefully I’ll be able to answer whether RadioShack is going to end up like Circuit City.

RadioShack Investment Overview

I’ve already laid out RadioShack’s business model and to sum it in a quick sentence, RadioShack makes more than half its revenue from selling mobile phones and accessories.

Here is how I view RadioShack after my review of the numbers from the stock analysis spreadsheet.

Financial Statement Notes and Trends

Going down each line of the financial statements and comparing the last five quarterly statements shows that RSH is clearly struggling on the income statement.

  • There is no growth in revenue
  • COGS continues to increase slightly
  • All margins declining
  • RSH is actually receiving tax benefits because it is losing money in terms of net income
  • The only positive is that RSH buying back a lot of shares. Management has made it clear that they believe RSH is cheap. They were buying in the $7 range.

Seeing the negative trends from the income statement, the balance sheet should also be showing a sorry story, but surprisingly that is not the case.

  • Cash balance is at historical averages
  • Inventory has been managed well. Since they sell mostly phones and contracts anyways, inventory shouldn’t be a problem going forward.

  • No short term debt
  • Long term debt has increased but they got a great deal. Paying interest of only 6.75% for unsecured notes.
  • The bad sign is the declining shareholders equity.

Free Cash Flow

This is what the Q1 report said about FCF:

Our free cash flow, defined as cash flows from operating activities less dividends paid and additions to property, plant and equipment, was $24.9 million for the first quarter of 2012, compared with $46.3 million for the same period last year. The decrease in free cash flow for the first quarter of 2012 was attributable to decreased cash flows from operating activities as described above and the payment of our quarterly dividend in the first quarter of 2012.

I don’t like to subtract dividends from FCF so I am going to add that back in to the equation. The report also clearly mentions capex which is great. Only shareholder friendly companies both to mention capex numbers.

Capital Expenditures: We estimate that our capital expenditure requirements for 2012 will range from $70 million to $90 million. Information systems projects and U.S. RadioShack company-operated store remodels and relocations will account for the majority of these anticipated capital expenditures. Cash and cash equivalents and cash generated from operating activities will be used to fund future capital expenditure needs.

If I extrapolate what they are saying, my guess is that 2012 FCF is going to come in around the $70 – $90m range. Owner earnings is going to be close to $0 on the negative or positive side. I.e. it could be -$10m or +$10m.

RSH Financial Ratios

Everything about RSH is in a serious decline and the ratios reflect that but the balance sheet is still solid.

RadioShack is a Net Net!

RadioShacks Net Current Asset Value is $3.88 per share. With the number of shares declining, the NCAV value could actually rise.

RSH has a solid balance sheet to support its current downturn and the NCAV should “technically” be the floor, but we all know how efficient markets are.

The fact that RSH is trading just below NCAV speaks volumes about what the market expects out of RSH. Absolutely nothing.

Stock Valuation Calculation

DCF minus the excess cash shows that RSH is worth about $1-$2 based on short term owner earnings in the $10m range.

A Graham formula valuation pegs the value around the $2 – $2.5x mark but earnings will likely decline so that range is in jeopardy.

EPV is actually negative but has a high asset reproduction value which confirms that RSH has no competitive advantage.

Despite all this, I bought a tiny position.

The thing to remember now is that RSH is no longer a typical investment. I didn’t buy it based on a Buffett’s principles but based on Graham’s principles.

RSH is a net net

  • that is profitable
  • has plenty of cash
  • not burning through the cash
  • has low interest rate payments
  • shareholder friendly management actively trying to increase shareholder value

I doubt RSH will ever turn to its former days, but that’s not why I hold net nets.

Summing Up

To answer the initial question of whether RadioShack will end up like Circuit City, I don’t think so.

If you read my first article, you’ll get the impression that I had no intention of owning RSH. But with these numbers, and looking at it from a different angle, it’s a tiny investment that I am willing to wait to see how things turn out.

Disclosure

Long RSH

About Jae Jun

Jae Jun has written 530 value investing articles.

Jae is the founder of Old School Value and has a mission to empower every investor by providing tools, tutorials and educational material so that they can invest successfully on their own.

Recent posts by Jae Jun

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  • Dan Synek

    So Jae, at what price will you buy more? They suspended their dividend, which will disappoint people who were attracted to 13.5 % dividend yield. It is useless to speculate, but a big drop would not be surprising, given how other companies who suspended dividend were punished (e.g. SUV – 50 %)?

  • Frank Tudor

    Jae, I jumped in a $7 and held till $5 under the same premise. I agree with previous poster about getting punished. Be prepared for the worst and hope for the best. I did get my dividend (last one. Maybe for a long time). I hate to say this but shorts are ready for murder and although volume is week, expect profiteers to bleed it some more out of this already weakend company. Now with all that bad, here is some good. The company is nimble. They have an effective and regular promotional schedule and Christmas is coming. For nothing else you might get rewarded for that alone. I would recommend averaging into your position in September when Christmas heats up. The funny thing about RadioShack is that it might be the only technology store for miles and miles in rural areas. Good for timely purchases when waiting for deliveries just won’t do.

  • http://studentofvalue.com Student

    At 2/3 NCAV – a Graham bargain or a buggy whip business?

    I liked it more when it was a hobbyist business for widgets, not a mobile phone vending machine. It’s presence and willingness to carry obscure items could have made it into a decent niche player – won’t happen with mobile phones.

  • http://www.oldschoolvalue.com Jae Jun

    @ Frank,

    Shorts are ready for anything to push the price lower. Christmas usually has the lowest margins with the sales and all and depends on how they push their phone sales. RSH still has to compete with the franchised mobile phone stores as well as best buy and other electronics retailers.

    Won’t be buying more just yet. Still plenty of time before this company turns the ship. Luckily I bought a 1% position so it is not affecting my portfolio by very much.

    @ Student,

    I’m going to say that it is a value trap based on what the market thinks, but over time, it will turn out to be a reasonable bargain.

  • Dan Synek

    Jae, Why does Fitch and you come to so different conclusions on RSH. Please comment! http://www.reuters.com/article/2012/07/25/idUSWNA190120120725

  • http://www.oldschoolvalue.com Jae Jun

    Probably because wall street is short term orientated. I just read a few lines and closed it because it’s just a regurgitation of what is obvious. They should have downgraded the debt 4 quarters ago if that’s what they believe. But like wall street, it was done after the fact.

    Oh I also want to point out that the declines in profitability and margin compression has been there for a few years so I know what I’m getting into. I don’t agree that RSH will not be able to pay off its debt though.

  • Keith

    LMAO. I, too, took a 1% position in RSH today at around $2.50.

    There was this homeless man that used to walk by my old office everyday and pick the cigarette butts out of those big sand-filled ashtrays outside the side door to the building. He’d light one up for the last remaining puff or two as he put the others in his pocket, presumably, to smoke later. I could see him from my window and used to think, man I’m glad I’m not that guy.

    Fast forward a decade or so, and here I am, a deep value investor, lapping up the gloom and doom, and looking for a cigarette butt of a company from which to get a puff or two before I burn myself… Most of the time, I get little more than a puff. But sometimes, I get much, much more.

    I haven’t felt this sick about a position in a long time. The last position that made me this sick was Ford at a buck-sixty. Who knows? Ford was facing nothing but gloom in early 2009 and turned out to be a six-bagger. I hope my nausea indicator is still working. :)

  • Keith

    @Dan Synek: Fitch is late to the party with triple hooks for RSH. The CDS market has been pricing in an RSH default for months. The big ratings agencies are always late, a high probability of default is now fully discounted, and if RSH rolls over its 2013 facility without issue (which I’m betting they will) I think this stock will pop into a good medium-term trade. For you investors, there’s also the longer-term turnaround story to watch. And for your speculators, there’s always the chance that someone will tender an LBO for a half-billion cash dividend at something close to 4 bucks/sh.

    At the very least, the stock has very strong support at zero. And it’s not all that far from there. :)

  • Harish

    Jun,
    What is your view on “NOTE 13 – COMMITMENTS AND CONTINGENCIES”. The section indicates 570 mill$ of minimum lease payments and 333 mill$ of purchase commitments. Isn’t the margin of safety lost if you include these into account. Hence, it is quite possible that Radio shack can go to Chapter 11 is operations don’t improve?

    Harish

  • http://www.oldschoolvalue.com Jae Jun

    @ Harish,

    That is one aspect I overlooked. Yes the lease payments are coming due. Will RSH go CH11? With its current balance sheet, I doubt it. They could easily renew their debt at attractive levels.

  • Dan Synek

    Jae, What does it mean that “the lease payments are coming due”. Are they not already declared as a cost each year? It would indeed be shocking if RSH has an extra cost of 570 Mil next year and each year the cost of renting their stores are not declared except in NOTE 13! I would appreciate if someone explained how this ” off-balance sheet financing” (as it is called in the RSH 10K) works!

  • Michael L.

    I think Harish is on to something, Jae.

    Leaving aside the purchasing commitments for a second, if you were to add just add the present value of operating lease payments back onto the balance sheet as a liability, I don’t think RSH qualifies as a net-net anymore. I discounted the minimum lease payments from the 10-K at the pre-tax cost of debt (~4.5%) and came up with a number of $518 million. Now you are looking at current assets of $1.74 billion versus total liabilities of $1.9 billion. It looks even worse than that if you pull the purchasing commitments onto the balance sheet.

    If the balance sheet isn’t providing a substantial enough margin of safety, then this is really a bet on the future earnings power of the company, and I don’t have a lot of faith that this business is going to generate a lot of cash going forward.

    The contrarian and cheap skate in me was very intrigued by RSH, but after taking a closer look at the balance sheet I think I am staying away from this one.

  • Keith

    These are operating leases so they are accounted for against income not against assets. This is perfectly normal. RSH retains no capital interest in the properties being leased so there are no extra assets on the balance sheet, and hence, the leases aren’t carried as liabilities. The leases aren’t payable in any one year but over all years in the lease term. They represent a hit to income of around $120M a year, if memory serves. This is just a cost of doing business for retailers.   

  • Keith

    A few directors did some buying on July 27th. This is not normally something I’d get overjoyed about, but in the case of RSH where they have a big facility to roll next year, any insider buying is a very good thing. If RSH was expecting to be locked out of credit markets, this would be something the directors would be privy to. Of course, they could be surprised, too. :)

    http://finance.yahoo.com/q/it?s=RSH+Insider+Transactions

  • Michael L.

    I understand that, Keith. But I think it is legitimate to ask whether the future lease obligations should be brought onto the balance sheet for the purpose of evaluating RSH as a net-net.

    A stock could be called a net-net if Market Value < Current Assets – Total Liabilities. This concept springs from Graham's idea that if you liquidated the company you should receive some fraction of the value of the current assets (and he wouldn't even give full credit for all of the non-cash current assets, if we are being strict about it). The key question is: Does the balance sheet as stated accurately reflect all of RSH's liabilities in liquidation or are there some things that it is missing. I don't know how easy it would be for RSH to break the leases without penalty, but in the absence of that info a conservative way to deal with these contractual obligations is to bring the present value of the future lease payments onto the balance sheet as a liability, which is what I was doing above. There would be an offsetting asset associated with capitalizing the lease, but almost all of that would be a long-term asset, hence it would receive no credit for net-net purposes.