Factors Lowering Our Valuation For RadioShack By Over 60%

RadioShack (NYSE:RSH) has been a prominent player in the retail business for over 90 years, but has been struggling to survive in the industry with rising competition from online retail giants such as Amazon (NASDAQ:AMZN), online auction sites like eBay (NASDAQ:EBAY), as well as other physical retailers such as Best Buy (NYSE:BBY) and Wal-Mart (NYSE:WMT). The entry of online retail giants has altered the landscape for the consumer electronics market. First, there is the practice of Showrooming, a practice where customers use physical stores to check out products and gain hands-on experience with gadgets, but use online stores to make the purchase.  It has negatively impacted sales of traditional brick-and-mortar retailers.

RadioShack is witnessing eroding top line growth, declining gross margins, high inventory levels, a string of debt maturities, and declining cash reserves. Its turnaround initiative, which primarily focuses on re-branding the chain and re-defining what it stands for, has failed to show any significant financial momentum so far. Its total revenue declined from $4 billion in fiscal 2011 to $3.4 million in fiscal 2013. The company reported its ninth consecutive quarterly loss in Q1 2014 as its net loss widened to $98 million compared to $28 million in Q1 2013.

The Radioshack stock fell below $1 in June this year and received a continued listing standards notice from NYSE on July 24, because its average closing price had fallen below $1 per share over a period of 30 consecutive trading days. Under NYSE rules, the Company has six months following receipt of the notification to regain compliance with the minimum share price requirement.

We have recently lowered our price estimate for the the company from $2.70 to $0.90. In this article, we discuss the key changes in our model that lowered our valuation for RadioShack.

See our full analysis for RadioShack

1. Declining Store Count (~20% Decline)

In our earlier model, we estimated RadioShack’s store count (U.S. company operated stores) to decline from 4,297 at the end of fiscal 2013 to approximately 4,200 by the end of our forecast period. We now forecast the store count to decline to below 3,700 over the same period. The change decreased our price estimate by 20%.

Consolidating its store base into fewer locations, while still maintaining a strong presence in each market, is one of RadioShack’s key initiative t0 turnaround its business. In its Q4 2013 earnings call, RadioShack announced its plan to close around 1,100 (almost 25% of its total store count) of its under-performing stores in the U.S., which is way above what we had factored in our model.

However, the company retracted its plan as it was unable to reach an agreement to do so with the lenders. RadioShack’s current credit agreements reportedly allow it to close only about 200 stores without the approval of lead lenders Salus Capital Partners and GE Capital. ^[1]. Nevertheless, in the absence of the consent, RadioShack plans to close up to 200 stores per year over the next three years. ^[2]

2. Stiff Competition & Higher Sales of Lower Margin Products to Restrict Margin Growth (~30% Decline)

Initially, we estimated RadioShack’s gross margin (excluding depreciation) would increase marginally in fiscal 2014 and remain constant thereon for the rest of our review period (reaching 35.7%), as the company’s store revamp drove sales up and inventory days down. However, as evident from its performance in the last few quarters, RadioShack’s restructuring initiative has yet to show any significant benefit. Thus, we have lowered our estimate and now expect only a marginal rise (0.5%) in 2014 gross margin. Though we forecast gross margin to increase marginally (to 35.4%) over our review period, we expect it to be significantly lower than the historical average.

Below are some factors that restrict growth in RadioShack’s gross margin –

– Higher sales of lower margin wireless products: RadioShack has been betting big on shifting its focus to mobility devices like smartphones and tablets, an area which is expanding fast but offers comparatively lower margins. Its revenue contribution from the mobility division has risen from 44.2% in 2010 to 52.4% in 2013.

– Competitive Pressure: Price competition from other established players can restrict Radio Shack’s top line growth and if the company does end up offering lower prices it will have to take a hit on its gross margins. RadioShack’s smaller footprint does not allow it to carry the breadth of products that would make it competitive vis-a-vis other brick-and-mortar retailers and online channels.

3. We extended our forecast period from 2021 to 2022 which led to an approximate 15% decline in our valuation.

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1. WSJ: RadioShack Mired In Talks With Lenders Over Store-closure Plans, Nasdaq.com, April 16, 2014 [↩]
2. RadioShack’s (RSH) CEO Joe Magnacca on Q1 2014 Results – Earnings Call Transcript, Seeking Alpha, June 10, 2014 [↩]