Is Radio Shack Poised for Another Double?

Much has been written in the press about my RadioShack (RSH) recommendation in June of last year.

At the time I recommended it, RadioShack had just replaced poor performing CEO David Edmondson with retail-turnaround guru Julian Day.

Mr. Day was just coming off a huge success, helping billionaire value investor Edward Lampert increase the operating performance of Sears Holding Corp (SHLD) after the merger between Sears and K-Mart.

The plan was to work his turnaround magic at RadioShack, and from what I could see by looking at the financials - it was very doable:

The first thing that you’ll notice is that from 1998 to 2005, sales increased from $3.5 billion to $5 billion. Not too shabby at first glance.

But over the same period, gross margins declined from 52.1% to 46.7%. That meant that the company was paying manufacturers more money for the products they were retailing. This is a very hard thing to do in an environment where China is making all sorts of electronics cheaper.

Operating margins also trended downward the entire time, going from a high of 14.4% to 9.3% in 2005. That meant the company had higher selling, general and administrative costs than they should.

In a period where the company paid down 10% of their debt – and lowered its interest expense - operating margins should have been going higher instead of lower.

Last but not least, net profit margins sank from 6.8% to a dismal 4.2%. In a company that does $5 billion in sales, that means a decrease in net income of over $120 million.

As I studied all this information, it occurred to me that from 2000 to 2006, one person was running the company - David Edmondson. It was only after he came on board that RadioShack's numbers fell apart.

Naturally, the stock price soon followed, with the shares collapsing from the $35 range to the $16 range.

Retail Distributor Turnaround Plan 101

Mr. Day knew, as do all good managers, that his first priority was to "right-size" the income statement.

That meant he was going to have to study the most important metrics in retail: revenue per square foot, cost per square foot and profit per square foot.

To increase gross margins, Mr. Day had to look at which products were least profitable and replace them, using the space instead for products that were more profitable.

To increase operating margins, Mr. Day would have to lay off hundreds, if not thousands, of good and honest workers through store closings and general releases.

(I know there was uproar about this, but the reality is that many of the workers who were laid off shouldn’t have been there in the first place.)

Based on Mr. Day's past experiences, neither feat seemed too difficult to achieve.

Indeed, every percentage point that a $5 billion company like RadioShack increases its profit margins means an additional $50 million in profits, which is an extra 37 cents per share.

Ultimately, the goal was for net profit margins to advance from 4.2% back to 7.7%.

In 2005 alone, that would have meant RadioShack's profits would have been $333 million, or 56% higher than what they were. As a result, per share earnings would have soared from $1.43 to $2.23.

At 15 times earnings, the stock would be selling in the $30 - 40 range.

A Classic Fallen Angel Stock

Forget new store openings. Forget additional revenue growth. And forget any big promises for world domination.

Based solely on a rebound in profits, it was clear to me that RadioShack shares were a bargain at $16.25.

But soon after recommending the stock, Wall Street seemed to wake up to the fact that RadioShack's problems were fixable and that Julian Day was the right man for the job.

Within months, the shares started moving upward, hitting a high of $35 earlier this year. (We sold the stock at $29.31.)

Is RadioShack a Buy (Again) at Current Prices?

But here we are in mid-October, and RadioShack shares are selling for $20, or 42% below its peak price earlier this year.

In the meantime, Mr. Day just keeps knocking the cover off the ball operationally. Here are some highlights from second quarter earnings, released July 30th:

• RadioShack Corporation today announced net income of $47 million (or $0.34 per diluted share) for the second quarter of 2007 versus a net loss of $3 million or $0.02 per diluted share.

• Cash balances increased to $630 million at the end of the second quarter of 2007, an increase of $460 million versus second quarter of 2006. The increase was mainly driven by the growth in net income, as well as improvements in working capital management.

• Gross margin rate for the second quarter increased 330 basis points over last year, from 47.2% to 50.5%. The increased gross margin rate was a result of improved inventory management and a more profitable product mix.

• SG&A expenses declined by $106 million or 22% for the second quarter of 2007. This decrease reflects a continuing effort to improve our return on expense dollars, most notably on payroll, professional fees and advertising.

So, with such stellar performance, why has the stock taken such a beating?

It's because Wall Street was spooked by a same-store sales (stores open at least one year) decline of 8.9%. In addition, total company sales declined by 15%.

But the declines mentioned above aren't a surprise to anybody who has ever listened to Mr. Day speak, or read anything that he's written.

Indeed, they're the direct result of Mr. Day's stated focus on closing unprofitable stores (481 at last count) and replacing unprofitable products with profitable ones.

As a matter of fact, everything so far seems to be going exactly according to Mr. Day's plan.

Does that mean RadioShack is a buy at $20 per share today?

Only if you believe that Mr. Day can execute Phase II of Retail Distributor Turnaround Plan 101 - the profitable growth phase.

And based on his track record, I'd never bet against the man.

Disclosure: none

Comments

[Concerned a...:]

The financials you speak of may be there but RSH has problems with their exsisting sales people which will inhibit any long term growth. Some of us in the field have experienced drastic cuts in our compensation. Since 2005, the best of us have had a cut of over $400.00 per month and since 2006 an excess of $200.00 per month. Those of is on the store level, the lowest rung on the ladder, have had to pay for the grievous mistakes of corporate management. In fact the better a salesperson is for the company in producing profitable sales the bigger the pay cut is rewarded to that radio shack sales professional, and sales mediocrity has been rewarded. The present compensation plan is not conducive to create profitable sales for the company. We get no commission on finished products regardless of its gross margin. It use to be the more we sell the more financial reward we would receive. With the present pay plan, this is no longer true. The executives get new bonuses along with their old bonuses while the sales professional pay is rapidly reaching poverty level. Some of us can not even pay the basic needs to live, whereas in the past, we could. Employee turnaround has increased; many district managers and store managers have left the company. If profit is to increase AND revenue increase, then experienced sales professionals who knows what they are doing in the field is necessary along with a fair sales compensation plan. The company forgets its the sales persons who bring the dollars into the company.

2007 Oct 19 01:28 PM

[Lewis Kornfeld:]

As RSH president 1970-1981, board member 1975-2003, and generally credited with having advertised and merchandised The Shack into the iconic brand it was prior to the Roberts/Edmonson succession, I must report that nothing I see is likely to restore the company's former success and image unless a very skilled merchant takes over quickly or the company gets sold to someone already winning at consumer electronics and who needs RadioShack's storefront distribution. Its advertising and merchandising today are dismal, and pretty soon the est. -10% same-store sales drops will overtake whatever Mr. Day has accomplished by cutting out the horrible fat taken on in the Roberts/Edmondson era. Its current "Do Stuff!" campaign dramatizes the lack of connection with real-time retailing. As a small plus, however, I do find the stores looking better physically. My stockholding is now down to 200sh. Lewis Kornfeld, [e-mail]. My offers to consult @ n/c - am 91 - have been met with silence, not the golden kind. Thanks for listening. LK.

2007 Oct 19 06:30 PM

[rs observer:]

It is so refreshing to see someone who not only can see through the short-term "success" Julian Day is enjoying, but also recognizes the dismal future RadioShack faces because of it.

You speak from experience rather than idol worship as I read so often on blogs giving Julian Day such glowing reviews for cost cutting measures which result in the rise of the stock prices.

Does Julian Day or anyone else in seats of power within RadioShack care about the consequences of some of the cost-cutting measures?

The store managers are so overworked and underpaid that they are now leaving RadioShack in droves, leaving less experienced managers in training to take over stores that they are not yet ready to run. Some stores do not even have managers because there are not enough qualified people available to take the position.

The inability to pay competitive wages eliminates the ability to keep the proper staffing that is necessary to maintain, yet alone grow the business. Why work at RadioShack when even serving fast food pays more? I know someone who works in a small coffee shop and makes more serving coffee than a successful RadioShack sales associate.

How can you give your customers the type of service they deserve, if you cannot pay competitive wages and staff the stores with knowledgable employees?

Julian Day's main goal is obvious. Raise the stock prices no matter the consequences. Stock prices are all that really matter to him...he's just putting in time until he can cash out.

He hates flying commercial airlines, so RadioShack pays for his private jet. I know of several store managers who have not had a day off in close to a month, are struggling to pay even the most elemental of human needs such as a mortgage, car repairs, health costs. They are struggling to live simply while their employer is flying around in a company jet.

Julian Day has taken a course that is destroying the morale of even the most loyal dedicated long-time RadioShack employee. He is so lost within his own little world of excess that he doesn't even give the people who are the face of RadioShack the slightest thought.

When someone walks into a RadioShack, they don't see Julian Day. They see the overworked, underpaid managers and sales staff...even the most dedicated has most likely reached the point of exhaustion or exasperation with the poor treatment and sub-standard pay they are receiving from their employer.

What a great face to put on a brand name that has been around for so many years. Good job Mr. Day.

2007 Oct 24 05:00 PM

[more right ...:]

I thought I would point out just how wrong you were about the future stock prospects of RSH. Have you looked at the stock lately? It closed today at $13.40.

Not only were you wrong about the future you don’t even have your facts right about the past.

First of all, the CEO of RadioShack from May of 1999 through May of 2005 was Len Roberts, not David Edmondson. Mr. Edmondson was CEO of RadioShack from May 2005 through February 2006.

Second the reduction in stores, that you gave Julian Day credit for, were announced and were in progress prior to Mr. Day joining the company. In addition the reduction in corporate staff that you gave Mr. Day credit for was also announced and put into action prior to Mr. Day joining the company. The reduction in advertising spending you give credit to Mr. Day for accomplishing was also announced and put into action prior to Mr. Day's arrival.

Mr. Day deserves credit for the execution of the plan but you cannot give him credit for developing the plan. That plan was developed by David Edmondson and his senior management team prior to Mr. Edmondson resigning from the company.

While Mr. Edmondson clearly made some mistakes in his personal life, you cannot and should not take away the credit due him for making some pretty tough decisions against the expressed desires of his direct boss, Board Chairman Len Roberts.

Mr. Roberts grew the top line through a single line of business, wireless phone sale. He let the balance of the business die on the vine and let cost get totally out of control.

Mr. Day got cost under control, but even to this day has no plan for what you refer to as the profitable growth phase. Did you attend the last shareholder meeting a few weeks ago? If Mr. Day has a plan he sure needs let someone know what it is soon, because without some articulated plan you should not be surprised when this stock dips below $10.00 a share. Look for that to happen sometime prior to the end of the third quarter.

Cost have now been cut to the bone and sales keep declining. Put those facts in your model and tell your readers the truth about what happens next.

Furthermore, sales will decline even more in future months because one of the Shack's major wireless carriers (Sprint) has tightened it's credit standards. Don't be shocked when wireless sales decline by 20% in the third quarter as a result.

You got the history wrong, you got the most recent past wrong...and you have the future wrong. I hope you will have the integrity to correct your mistakes and lack of knowledge in as public a way as you made them.

2008 Jun 11 02:22 AM