This article is a reprint of my March 10, 2008 RealMoney column
- I don’t expect RadioShack to grow.
- But it should be worth buying as long as they can limit their cash flow declines to 5% or so annually.
- Combined with a put-write strategy, it looks even better.
RadioShack (RSH) is a company investors love to hate, and it isn’t hard to see why. Stocked full of stuff you occasionally need but often find elsewhere, it represents the unsexy part of consumer technology – wires, batteries and cables that you forgot to pick up when you got the HDTV or game console at your local Circuit City (CC) or (more likely) Best Buy (BBY).
What’s more, RadioShack’s 4,400-odd company-owned stores, on average, sold 6.7% less stuff in the fourth quarter of 2007 than they did in 2006. This is an improvement from the full-year same-store decline of 8.2%, which is partly attributable to the fact that 525 stores have been closed since year-end 2005. Many of these, presumably, were the worst-performing ones. Having fewer of the really bad ones open for the last 12 months will contribute to improving same-store figures.
Now that the low-hanging fruit has been picked, investors need to figure out whether what remains is worth climbing what could be a rickety ladder. Most investors tend to shy away from companies that aren’t growing, and generally flee from those that are shrinking. Still, even shrinking companies are worth something, and investors can be rewarded if they pay the right price.
The valuation is certainly cheap, at ten or eleven times earnings. My preferred measure, the free cash flow yield, is a downright juicy 14.3%. With that kind of cash flow yield, RSH could generate double-digit returns even if cash flow declined 4.3% per year. With five-year Treasuries yielding just 2.5% the declines could be even larger and still earn investors the typical risk premium that would be expected for holding stocks.
With the question thus changed from whether RadioShack can ever grow again, to how much shrinkage is currently priced in, the analysis becomes a bit less sticky. For this, I think I’d accept a return in line with that of RadioShack debt – which reflects the company’s relative risk and allows for a modest premium based on the more favorable tax treatment of equity returns.
RadioShack’s May 2011 note is currently yielding about 7%. To generate equity returns higher than this, RadioShack will have to limit its free cash flow declines to 8% per year – in other words, they can’t get any worse.
RadioShack attributed the same-store sales weakness in 2007 to “a decline in postpaid wireless sales for our two main wireless carriers.” Wireless sales account for a third of RadioShack’s business and those two carriers are Sprint (S - Annual Report) and AT&T (T - Annual Report). Sprint’s performance has been pathetic, while AT&T is relatively weak in the Northeast, particularly RadioShack’s largest market –
Investors seem to be picking up on the potential value, as the rally following the latest earnings report has given the shares some fragile support. Given the state of the economy and particularly RadioShack’s wireless exposure, I think the company will eventually stem the bleeding to within my acceptable range, but probably not this year.
As is often the case, though, I think the doubt can be addressed by using a put-write strategy to enhance returns and further reduce the potential entry point. As I write this, April $15.00 puts are selling for $0.80 – a 5.3% premium on money that is risked for about six weeks. If the stock declines and the options are exercised, the effective entry price would be lowered to $14.20 – a price that would boost the effective free cash flow yield to 17.8% and increase the margin of safety to permit an acceptable return even with annual free cash flow declines of 10%.
That starts to look like a risk worth taking.
Disclosures: William Trent has written put options against the shares of RadioShack (RSH)