Rising Star Buys: Radio Shack and Best Buy

This article is part of our Rising Star Portfolios series.

Radio Shack (NYSE: RSH  ) and Best Buy (NYSE: BBY  ) aren't popular these days.

Over the past year, the S&P 500 is up 18%. Radio Shack? Down 24%. Best Buy? Down 13%.

They are specialty retailers in an increasingly competitive space: electronics.

We know Amazon.com (Nasdaq: AMZN  ) and its Internet retailer brethren are coming strong. So are the bricks-and-mortar competition like Wal-Mart (NYSE: WMT  ) . And so is the wireless industry -- with companies like Verizon and Apple competing with their own stand-alone stores.

The first two nip at Radio Shack and Best Buy on price, the latter two on specificity.

And, honestly, I'm not really that stoked about the prospects of Radio Shack or Best Buy in the long term (think 10 to 20 years from now).

So why am I interested?
Primarily price.

Radio Shack trades at a trailing and forward P/E ratio of 8 while Best Buy's at 10 and 9, respectively. And those numbers are about the same when we look at them on a trailing cash flow basis (using enterprise value to free cash flow).

Now, price is nice, but we have to have at least some faith in their ongoing operations.

The case for Best Buy
The case isn't hard to make with Best Buy. While it's seen some margin compression in recent years, it's been able to grow its top line pretty consistently. When a company's trading at price multiples of 10 or lower, not much growth, if any, is factored in. While it faces increasingly stiff competition, I think its value proposition of being a physically located, specialized, one-stop-shop for electronics has some legs for the medium term (the next few years, at least).  

The case for Radio Shack
The case is harder to make for Radio Shack. When I say "Radio Shack," you're probably thinking two things: (1) How the heck is that place still in business, and (2) isn't it just a clubhouse for nerds to get replacement parts for their ham radios and Ataris?

Before you pre-judge, check out this stat. I'm setting phasers to stun:

Radio Shack has made a profit in each of the last 17 quarters!

That means Radio Shack was pumping out profits throughout our housing meltdown and recessionary problems -- all the way back to the fourth quarter of 2006.

That's the same year Radio Shack hired Julian Day as its CEO. He had previously won kudos for his work in resuscitating Kmart. Under Day, Radio Shack has seen serious cost cutting, a rebranding campaign focused around "The Shack," and an increasing emphasis on being a multi-carrier wireless store (more than a third of its sales are from wireless). And while its kiosks at Sam's Club are being discontinued, Radio Shack is ramping up a larger wireless-featuring kiosk deal with Target (NYSE: TGT  ) .

Still, its emphasis on wireless in its stores, while a lifesaver, is dangerous since Radio Shack will face more competition from the very providers and hardware makers whose products it sells. And with its butt-kicking CEO stepping down in May, Radio Shack's ability to respond is in question.

But at its current stock price, I'll take that chance.

The takeaway
I try to take my opportunities where the market is presenting them. Right now, the market is discounting the prospects of Radio Shack and Best Buy. They may not be the best businesses out there, but they're pretty cheap, they have solid balance sheets, and they've shown a good track record of profitability. As evidence of the profitability, note that their five-year price multiples on earnings and cash flows are close to their one-year multiples.

I'm not expecting a home run from either (though I'd gladly take it) but rather a solid, market-beating performance.

My thesis hinges on two things: (1) the businesses of Radio Shack and Best Buy staying steady (or growing!) over the short to medium terms, and (2) the market upgrading its hatred to lukewarm thoughts sometime in the next three to five years.

I believe strongly enough in this thesis that tomorrow I'll be buying shares for my Motley Fool-funded real-money portfolio. You can see all of my real-money picks by clicking here.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. Click here to see all of our Rising Star analysts (and their portfolios).

Anand Chokkavelu doesn't own shares of any company mentioned. Best Buy and Wal-Mart are Motley Fool Inside Value selections. Amazon.com and Best Buy are Motley Fool Stock Advisor recommendations. Wal-Mart is a Motley Fool Global Gains selection. The Fool owns shares of Best Buy, and Wal-Mart. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 25, 2011, at 11:29 AM, valuehunter007 wrote:

    I do not have favorable or un-favorable opinion for BBY. Though it would be a mistake in my opinion to purely rely on forward P/E. Before Circuit City went down it was also trading at not-too-expensive forward P/E. :-)

    I have unfavorable opinion on Radio Shack and I don't think it is a "Rising Star". It infact seem to be a falling star.

    RadioShack Free Cash Flow has been consistently declining over last few years.

    FCF -

    2007 - 334 mil

    2008 - 189 mil

    2009 - 165 mil

    2010 - 75 mil

    Another concerning fact is FCF/Sales %

    FCF/Sales%

    2001 - 13.33

    2010 - 1.67%

    And in between the years it has been declining to finally bring it to 1.67%. This tells me that they are not generating much cash of the sales and definitely declining.

    FCF/Net Income is also lowest in last 10 years for 2010.

    For a rising star I would think these are the basic numbers that has to improve isn't it? Your thoughts? :-)

  • Report this Comment On February 25, 2011, at 4:14 PM, TMFBomb wrote:

    @valuehunter007,

    You've highlighted the main question on these two -- are Best Buy and Radio Shack value traps because they're companies in rapid decline or (as I argue) are they more stable businesses than the market is pricing?

    Regarding the free cash flow generation of Radio Shack, at least some of the drop in cash flow is due to inventory build-ups in anticipation of its Target Mobile kiosks. Although this is certainly something to monitor, my rejoinder is that Radio Shack is still trading at a low multiple on even these depressed cash flows.

    -Anand

  • Report this Comment On April 04, 2012, at 6:27 PM, TMFHockeypop wrote:

    If you perhaps want a more conservative alternative, the 10/15/2019 RSH bond is selling at about 80% or a Yield to Maturity of 10.8%. If the company is close to as bullet proof as you say, you can either believe the evidence that stocks may likely keep their sideways performance and pocket the almost 11% per year. If not take 3.5% (or the inflation rate) of the semi-annual payout and buy the stock. You've hedged the downside, provided for some upside, and gained about a 7+% return. Not a bad way to deal with what may continue to be a turbulent seven years.

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