Electronics retailer Radio Shack (RSH) has been awash with news lately. In addition to getting removed from the S&P 400 Midcap Index, the company announced CEO James Gooch will leave the company immediately. CFO Dorvin Lively will take his place on an interim basis. So the question arises, are shares of the beleaguered retailer finally attractive?
Before we address the business, we'll speak to the senior management team. We have been incredibly baffled by the firm's capital allocation strategy. When it was clear the company had structural issues, the company decided to take on debt to repurchase stock and pay a sizable dividend. At best, Gooch seemed to be in denial of what was happening to his business. Lively, on the other hand, doesn't have any track record leading a company. He's been a CFO or corporate controller for the past several years of his career. However, under his brief reign, Radio Shack's debt has been reduced to a junk rating, and the firm continued to pay its dividend until July. We're not sure if Gooch forced his hand with regards to the situation, but we ultimately don't think Lively will run the company for long.
The business itself remains incredibly challenged as it transforms its perception and business model. We think most consumers still see Radio Shack as a place for hobbyists and those unwilling to adopt new technology, while, in reality, the company is attempting to become a hub of mobile phone sales and information. However, sales have yet to decline precipitously, as same-store sales were basically flat during the second quarter and aggregate sales were up 1.2% year-over-year. Yet, margins are deteriorating precipitously, and competition within the smartphone space is fierce. Not only does Radio Shack have to compete with the mobile carriers, but Best Buy (BBY) will also invest heavily in the space, and Amazon (AMZN) sells smartphones (and seemingly doesn't care about near-term margins).
That leaves Radio Shack as a brand with negative perception that is trying to transition a business model that will only face stronger competitors. On the positive side, the firm's balance sheet hasn't completely deteriorated-yet. Operating cash flow is down 77.4% year-to-date relative to last year, and the firm isn't debt free by any means. We've previously questioned the liquidation value for equity holders in the event of a bankruptcy, and our doubts remain. Though the firm trades a tremendous discount to our fair value range, we prefer staying on the sidelines in situations where the business might decline too quickly for investors to extract value from the balance sheet.
Until we see a healthy uptick in free cash flow and a successful transition to a business model we view as sustainable, Radio Shack remains a classic value trap.