RadioShack Needs Big Changes To Fight Negative Trend

RadioShack (NYSE:RSH) recently announced its Q2 results with a modest increase in revenues and a significant decline in gross margins over the same period last year. The shift within mobility sales towards lower margin smartphones was the key driver behind declining margins. The stock has plunged more than 30% since the earnings release on July 25 .

We have revised our price estimate for RadioShack to $3.71, which implies a premium to the market price. We believe, at present, the stock is trading at a discount to its fundamental valuation due to the negative sentiment surrounding the stock following the recent earnings release.

We have updated the company’s net debt position and have discussed below the changes to our key estimates for RadioShack.

See our complete analysis for RSH stock here

Number of U.S. RadioShack company-operated stores

Amidst cost pressures and margin pressures, we expect RadioShack to resort to store closures in the coming years in order to save costs. Brick and mortar retailers are finding it hard to compete against online retailers like Amazon (NASDAQ:AMZN) and eBay (NASDAQ:EBAY). Its rival, Best Buy (NYSE:BBY), has decided to close 50 of its large-format stores in the U.S. in order to save costs.

• Present store size renders inefficiency: We believe it will be a wiser decision for RadioShack to do away with their present store size as the share of consumer electronics in their business is declining and that of mobility is increasing. For mobility, firms needn’t have large-scale presence which, in turn, also entails higher costs. RadioShack’s present store size which stands around 2,500 square foot per store is too large to sell just wireless and smartphones and too small to incorporate a wider selection of consumer electronics products. For instance, Best Buy’s large format stores (38,500 sq ft)  and standalone stores in the U.S. (1,800 sq foot ) and Europe (600 sq ft) offer a much better store layout experience to customers.

• Problem of showrooming: Customers visit brick and mortar retailers like Best Buy and Target (NYSE:TGT), check the product and eventually buy it at a cheaper price online. This trend has started to adversely affect the revenues of the brick and mortar retailers. Thats the key reason why these retailers are focusing on their online sales.

Considering the above mentioned trends and changing nature of the retail industry, we have revised our store count estimates for RadioShack and believe that in the coming years it will resort to store closures.

Gross margin

We believe declining gross margins will remain a significant issue for RadioShack. Higher mix of smartphones and significant growth in Target business (post paid) are the major reasons behind declining margins. The company expects margin pressures to continue in Q3, however, in Q4 it expects improvement in margins and operating profits.

Excluding the postpaid wireless business, the gross margin rate for RadioShack has remained flat. We have revised our estimate for RadioShack’s gross margins and expect them to witness a decline of 1% in 2012.

• Consumer electronics witnessing major shift: The declining demand for consumer electronics products like televisions, notebook computers, gaming and music is an industry-wide trend. Firms like RadioShack are struggling due to uncompetitive pricing and slumping demand for these products. Present day customers are more inclined to buy mobile phones, tablets, e-Readers. However, smartphones relatively entail lower margins and, thereby, curb the overall company margins.

The dismal performance by RadioShack over the last couple of quarters has led to a consistent and a significant fall in its stock price, thereby, eroding its market capitalization (presently below $250 million).

Selling, general and administrative as a % of Revenue

With increasing competition, we expect the share of promotional programs and advertising to go up. RadioShack is in dire need of rebuilding its shattered brand image and in developing a connect with the customers.

It has launched several initiatives in order to remain competitive like low price guarantee, free mobile support, Trade & Save program. However, these programs couldn’t help the consumer electronics retailer in improving its performance. We expect more such programs to follow in future, thereby, increasing the associated selling costs.

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