RadioShack Will Survive

RadioShack (RSHCQ) offers disproportionately high upside because of its undervalued common stock and improving business prospects. In the past year, RadioShack launched a five-point plan that could provide it with the capability to compete with larger retailers such as hhgregg (HGGGQ) and Best Buy (BBY 1.09%).

The hiring of turnaround consultant AlixPartners and investment bank Peter Solomon could speed up the process of value surfacing in RadioShack's shares. Also, the company is reducing its SKUs (stock keeping units) by about 25% and moving away from providing hardware for the "do it yourself" customer to focusing on software-oriented products. Together with a recovering domestic economy, this makes RadioShack an interesting investment option.

Fundamentals and valuations

Source: SEC filings, Reuters as of Aug. 23 

The table shows that RadioShack has the lowest valuation, the highest gross margin (meaning the most expensive products) and the lowest operating margin. It seems like hiring a turnaround consultant and replacing executives were the right decisions. Going forward, RadioShack has the largest potential among its competitors to improve its operational performance, and its shares offer the largest upside potential.

For example, the company has the largest footprint in the U.S. with 4,395 company-owned stores and 1,014 dealer and other outlets as of the end of its most recent fiscal year. Importantly, the average size of a company-owned store is only 2,464 square feet, which has turned from a disadvantage into an advantage. RadioShack is:

• Reducing the number of its SKUs

• Improving its online shopping capabilities

• Moving from hardware-oriented products to more software-driven products

For comparison, hhgregg and Best Buy operate 228 (in 20 states) and 1,503 stores, respectively, with an average size of 32,000 and 30,760 square feet, respectively.

Liquidity

Source: SEC filings, Reuters/*Principal amount repayment of the company's August convertible issue.

When a retail company such as RadioShack trades significantly below book value, equity investors should be concerned about the company's liquidity. RadioShack has the largest amount of debt, but it also has the largest amount of cash in proportion to its debt. It is also the company with the highest quick ratio (current assets – inventories and prepayments divided by current liabilities) and the highest current ratio (current assets/current liabilities).

RadioShack has a larger interest expense as a percentage of sales. However, RadioShack had $432 million in cash as of the June-ended quarter, compared to $23.1 million for hhgregg and $908 million for Best Buy (as of May 4). It seems like RadioShack can survive short-term stress and it will be able to profit from its leverage if the turnaround is successful.

Initiatives

RadioShack has recently undertaken the following major initiatives:

• Reposition the brand – introduced a new brand strategy called Let's Play (see video), ended its partnership with Target, closed about 1,500 kiosks selling mobile products at Target, started its products in college bookstores.

• Revamp product assortment – reduced in store SKUs by 25% to about 3,000 and started paying a commission to employees who sell all products -- not just mobile, focused on innovative products such as software based (electronic health for example) and audio products.

• Reinvigorate stores – opened a new concept stores in Manhattan with plans for about ten concept stores by year-end that will feature brand specific sections (Apple and Samsung for example) and more fun and interactive options for customers.

• Operational efficiency – hired a new CEO (Joe Magnacca who helped turn around Reed and sell it to Walgreen's) and AlixPartners (a turnaround firm) and started using its stores as mini fulfillment centers.

• Financial flexibility – hired Peter J. Solomon in an effort to strengthen its balance sheet.

Due to the above initiatives, RadioShack's sales and margins are likely to get worse before they start improving in 2014. For example, the company incurred $7.9 million of losses during the first six months of 2013 related to closing its Target kiosks. Also, due to the reduction of its inventory and related discounts, its sales and margin levels are under pressure. Finally, hiring a turnaround consultant and appointing a temporary CFO who works for the consultant and not RadioShack could be risky.

Similar to RadioShack, hhgregg and Best Buy are taking new initiatives to compete better with online retailers and to gain more consumers who are increasingly price sensitive. For example, hhgregg is refining its fitness equipment offerings and increasing the number of its appliance and furniture products. Fitness equipment, major appliances and furniture are some of the few items that consumers still buy predominantly in brick and mortar stores. And Best Buy is introducing mini-concept stores of brands such as Apple, Samsung and Microsoft. It seems like RadioShack initiatives are more pronounced and diverse and should carry larger benefits if successful.

Conclusion

RadioShack is currently undergoing a major reorganization, but the company has more liquidity than competitors hhgregg and Best Buy. Investors looking to invest in a unique consumer-electronics retailer with a large footprint in the U.S. should consider RadioShack.

Traditional retailers are increasingly pressured from online e-commerce websites and it seems like RadioShack is actively trying to adapt to this new reality. It is unlikely that RadioShack will go out of business, as mentioned in this recent Reuters report. The upside in RadioShack's stock price, if this turnaround is successful, seems to outweigh the risks.