High-yield is a scary segment of the equity-income universe, given that dividends can and do get reduced and eliminated, something that will happen to you at times if you regularly play this area. Nevertheless, risk is part of the equity landscape (otherwise, we'd all be 100% in treasuries) and applying a bit of elbow-grease to high-yield stocks can, actually produce good results. I've written before on Seeking Alpha about a stock screening strategy along these lines which I refer to as Prudent Yield Hog, and the latest fine-tuning of this protocol, the one I'm now using with real money, produced a total return of 6.2% in the 2012 first quarter, and backtest results suggest an annualized total return of 10.0% from 12/31/03 through 3/28/12. These numbers compare well to benchmarks: The iShares Select Dividend Index (DVY) returned 4.71% in the 2012 first quarter and delivered 3.77% annual returns from 12/31/03 through 3/28/12. The iShares Dow Jones US Utilities ETF (IDU) lost 2.31% in the 2012 first quarter (a reasonable correction following an incredibly strong 18.67% gain in 2011) and returned 7.84% annually from 12/31/03 through 3/28/12.
Today, I'd like to look closely at RadioShack (RSH), a stock that's often on my high-yield screen and which is among those I currently own.
- To paraphrase the Virgin America pre-flight announcement ("For the .0001% of you who've never used a seatbelt . . ."), for the .0001% of you who've never seen a Radio Shack store, the company is a consumer electronics retailer that was pretty cool way back in the early days of this sector (back when portable radios were considered high tech) but which has lost considerable luster over the years as the masses became more technologically proficient and demanding and as big-box chains and on-line retailers ascended. And some of the merchant's problems were its own fault: It got into super-stores (Incredible Universe) back when Best Buy was a struggling regional chain most consumers hadn't heard of, but made a mess of it paving the way for others to take over that part of the business.
- Lately, though, the stores have cleaned up with improvements ranging from appearance to operational practices (Hooray, I can now buy batteries there without being dunned for my home address and phone number). As to the overall consumer-electronics landscape, I appreciate that I can actually walk to one store and that another is much closer to home and less hassle than the nearest Best Buy, which can make a difference if I need little things ("Oops, I forgot that connector; oh well, I'll just run down to Radio Shack and be back in a few minutes"). And if one wants, bigger-ticket modern products can also be purchased there.
- The stock currently yields about 8%. Given where mainstream interest rates and yields are today, we have to assume a number that large reflects widespread expectations that the dividend is not secure.
- It's hard to say exactly where RSH fits within today's consumer-electronics landscape. As convenient as it is for little things, I'm not sure that alone is enough to sustain the business, and competing in big-ticket is hard.
- With no store being able to achieve serious scale, when the consumer-electronics sector sneezes, Radio Shack is likely to be laid low by the flu. And lately, economic trends hadn't been kind to this sector.
- Margins are under pressure, which is saying something since the company is often a high-priced competitor (it's that scale thing). The reason, lately, has been an emphasis on mobile, which is a low-margin retail area in its own right. That situation has lately been exacerbated by a phase-out of T-Mobile products and the gearing up of a switch to Verizon Wireless offerings.
- Financial performance has been disappointing and the company has been lowering guidance over the past three months.
- The trailing 12 month dividend payout ratio, 73%, looks weak.
- Sentiment is dreadful. Of the 21 analysts whose recommendations are tracked by Thomson/First Call, 1 has a Strong Buy, 16 rate the stock as Hold, and 4 rate it Underperform (the last two categories are about as close as Wall Street analysts usually get to saying "Sell"). Short interest stood at 29.6 million shares on 3/15/12, up from 11.2 million three months.
- Sentiment is dreadful, as evidenced by poor analyst ratings and escalating short interest. That was cited above as a negative, but it can also be seen as a positive. If any good news at all surfaces, look out above!
- The headline 74% payout ratio and the bad EPS numbers are what they are, but stock analysis requires digging below the surface. EPS from continuing operations for 2011 was $0.65, versus $1.55 a year earlier. But ex non-recurring items (mainly the wireless transition and also charges relating to closure of a plant and early retirement of debt), the tally would have been $0.95 a share versus $1.68 a year earlier. That's still bad. Even aside from special mobile transition expenses, this low-margin area has been a bigger portion of the business mix. But it's not as if the company is going broke. The dividend payout ratio adjusted for unusual charges was a more respectable 47%. Moreover, the $49.6 million in dividends paid in 2011, a bad year, amounted to only 22.8% of the $217.9 million in cash from operations, and 36.5% of cash from operations minus $82.1 million in capital spending.
- The numbers above suggest the dividend is affordable. The RSH board seems to think so. Its latest dividend adjustment, made in October 2011, was to double it, from an annual payout of $0.25-per-share to $50-per-share. And the new dividend will be paid quarterly, consistent with what income investors are accustomed to, as opposed to the past practice of paying the whole thing once per year.
- At the same time as the dividend-doubling announcement, the company also announced a $200 million share buyback.
- Speaking of the annoying mobile transition, let's remember the details: RSH is going form T-Mobile to Verizon Wireless. Unless I've had an incredible brain freeze, I'd think that a transition that brings Verizon Wireless in would be a good thing.
- While RSH still needs to find a winning domestic formula and talks about returning cash to shareholders, it has not given up the ghost on growth. It announced a deal wherein Berjaya Retail Berhad, a Malaysian franchisor, signed a master franchise agreement to bring Radio Shack to 10 Southeast Asian countries in a variety of formats (stand-alone stores, mall-based stores, strip-mall stores, kiosks, etc.). We have to remember that not every consumer-electronics buyer is running to an Apple Store or a big-box chain to scarf down the latest and greatest offerings. This deal seems like a low-risk way to try to bring Radio Shack to a larger number of consumers who might be more amenable to the company's smaller-scale more personal way of selling less-than-premium products.
- I think that in today's information age, with facts all over the place and easy to uncover, the sort of knee-jerk contrarianism that is so delightful to so many is dangerous. So I cannot bring myself to brush aside the cons here.
- As things stand today, I find the stock hard to resist. The question is whether the status quo will, at least, hold.
- The big risk, here, is that the company continues to struggle to define a domestic business model that has staying power and that the numbers deteriorate. Today, RSH is more than profitable enough to pay dividends and repurchase shares, but if it's to continue to be able to do so down the road, it will probably need more strategic solidity than is the case now, and that is not a shoo-in.
- That said, the company is not immediately under the gun. It has the time and it has the financial flexibility it needs to get it right, or at least to become passable (with a yield like what RSH offers, we don't need brilliance; adequacy will suffice).
- Relative to other high-yield equities, I think the risks here are tolerable.
Disclosure: I am long RSH.