Sometimes the best investment opportunities are right in front of you and, for one reason or another, you fail to take notice. This is the surprising case of how I failed to notice RadioShack’s (RSH) remarkable performance for far too long.
I can tell what you are thinking. RadioShack … is that company still around? Who possibly shops there when there is a bigger selection of electronics at Best Buy (BBY)? I shared these views for years. The first retail business I owned was located just a few doors down from a RadioShack location, and it never occurred to me to make big electronics purchases there. I would shop there only when I needed something quickly, like new batteries or a network cable – small purchases that didn’t justify making a trip out to Best Buy.
It appears my behavior isn’t unique, and this provides RadioShack with a big advantage. Consumers are relatively price-inelastic when it comes to these small necessity items. When a battery dies, you need a new one, and concerns over the cost of replacing it are usually trumped by convenience. Let’s compare RadioShack’s gross margins relative to Best Buy’s:
[Click all to enlarge]
RadioShack vs. Best Buy, 1994-1Q 2011
RadioShack’s gross margins are significantly higher than Best Buy’s. Best Buy has done quite well riding the growth in personal PCs and other items, generating significant revenue growth. But this growth has been in relatively lower margin items. On the other hand, RadioShack has experienced relatively flat revenue but maintained exceptionally high gross margins. Their strategies differ, and neither is inherently better (In fact, I think Best Buy is a fantastic value opportunity as well).
It seems that, while RadioShack lacks the sexiness of a big box retailer with massive revenue growth, it is running an incredibly stable business targeting a particular demographic that isn’t price-conscious in a market with relatively less competition.
Let’s see how the company has behaved as a steward of shareholder wealth.
RadioShack returns, 1994-1Q 2011
This chart shows how, for more than a decade, RadioShack’s management has been generating returns on a variety of metrics in double digits, from the mid-teens all the way up to the high 30s. Pretty impressive. Before you email, the answer is No, I have not included operating leases in the chart here, as there is a considerable number of assumptions implicit in calculating the present value of operating leases – the bulk of which stem from the generally poor disclosures required of companies. This should be changing soon, but in the meantime if you want to know the effect of these, you’ll have to do your own calculations using your own assumptions.
Readers of my multi-part review of Financial Shenanigans will know to check for (at least) two other things. First, let’s check the company’s cash conversion cycle to identify any potential shenanigans related to inventories, aggressive revenue policies and one-time boosts:
RadioShack Cash Conversion Cycle, 1994-1Q 2011
Though the company does not enjoy the awesome cash conversion cycle of Dell Inc. (DELL) and has a significantly longer cycle than Best Buy, the company has had relatively stable levels over a long time, suggesting a low likelihood of a number of financial shenanigans. This appears to be part of the company’s strategy of focusing on higher margin, slower moving items. As the company expands its online sales, these levels may come down.
The other important thing to note is any potential divergence between the company’s reported comparable sales change and our own calculation of total revenues/average stores open. This helps identify when new stores are underperforming, or when management is fiddling with their definition of comparable stores, which is a red flag.
RadioShack Store-level Sales Growth, 1997-2010
From this, we see that my calculated figures of sales growth among company-operated stores has tracked closely with the company’s provided comparable store sales growth figures. This is a good thing.
So let’s sum up. Boring company? Check! Stable operations? Check! Conservatively capitalized? Check! Strong returns? Check! I’ll paraphrase Teddy Roosevelt: “Walk softly and carry a big stick.” That’s exactly what RadioShack appears to have done over its history, quietly racking up fantastic performance while Mr. Market directs its fickle attention elsewhere.
In valuing RadioShack, I looked at a variety of scenarios -- some bullish, some bearish -- and concluded that, at the current share price ($13.38 as of July 13), the company has a sizable margin of safety unless making extremely pessimistic assumptions. You can draw your own conclusions about how the future will play out, but I am happy with the odds Mr. Market is providing (the company is trading down ~29% YTD).
One more thing before we end. The company has been a massive repurchaser of shares over the last decade, returning a significant amount of cash to investors. Not bad.