RadioShack Earnings Preview: Grim News Expected

RadioShack (NYSE:RSH) has announced that it will release its Q3 results on October 23, 2012. The company’s stock price has plummeted after the departure of its CEO, James F. Gooch, and its dismissal from the mid-cap index of the S&P Dow Jones Indices. In a way, his departure only confirmed that the company is facing a mountain of troubles. ((RadioShack CEO Departs After a Year, WSJ))

The stock has shed 80% of its value over the past year, and the company has been struggling with higher costs amid declining sales in its more profitable consumer electronics division. Last quarter, the company reported a modest increase in revenues and a significant decline in gross margins over the same period last year. But over the last four quarters, revenue has fallen an average of 1.1% year-over-year. The biggest drop came in the first quarter, when revenue fell 5.2% from the year-earlier quarter. The shift within mobility sales towards lower margin smartphones was the key driver behind declining margins. We expect the trend of declining margins to continue this quarter. ^[1]

A lot of blame for the company’s decline can be heaped upon industry factors which have shifted to RadioShack’s disadvantage, but the company is equally guilty of failing to adapt itself to the changing nature of the business. The business model looks outdated and there seems to be no catalyst to drive future growth.

See our full analysis for RadioShack

There are plenty of reasons to have a grim foreboding about this quarter’s results.

Changing Nature of Consumer Electronics Retail

Retailers like Wal-Mart and Amazon are taking business away from pure-play consumer electronics stores by offering huge discounts. Customers are still using physical stores to check out products and gain hands-on experience with gadgets. However, a large number of them then proceed to buy these from online stores like Amazon at cheaper prices. This phenomenon of show rooming has hit business hard for companies like RadioShack. The trend has been accelerated by changing consumer spending habits, which are shifting from high discretionary spending and debt taking to higher savings. ^[2]

Rivals like Best Buy (NYSE:BBY) are rapidly seeking to adapt to the new market reality by investing in building a robust online presence. RadioShack seems to be late to the party with its Omni-Channel initiative. While it has been listed as a key initiative for this year, we have yet to see any results. ^[3]

Lopsided Focus On Wireless Becoming A Liability

Historically, a major portion of RadioShack’s sales have come from the wireless segment. However, its wireless partner Sprint has been falling behind the competition. Sprint’s changes in customer and credit models have caused RadioShack’s sales and profits to fall. ^[4]

It is true that the company has been betting big on shifting to mobility devices like smartphones, but the problem here is again low margins. This segment is intensely competitive due to the presence of a large number of players. These include not just traditional rivals like Best Buy and players like Amazon, but also Apple Stores, plus AT&T and Verizon outlets. While devices like an iPhone contribute to higher sales due to big ticket prices, they yield very low margins due to the intense nature of the competition. ^[5]

In all fairness, RadioShack is taking certain steps to improve its gross margins. In the Mobility platform, the company is looking to leverage the emerging trends towards the prepaid wireless plans with the most recent launch of no-contract iPhones with Virgin Mobile. While there is a high upfront cost to cover the handset for the new iPhone, the monthly rates are much lower, and there is no contract or breakage fee for the customer. This caters not only to customers who are credit-challenged with the postpaid offers, but also stronger credit customers who don’t want a high monthly cost, or are looking to avoid the commitment associated with breakage fee. We are skeptical that this will be enough to provide a significant boost to gross margins. ^[6]

Lack Of Strategic Foresight

The company has not sought to diversify like Best Buy has. The latter has forayed into providing cloud services as well as a third-party market place to offer online products from other sellers in exchange for a cut from the proceeds. ^[7]

The company’s capital allocation strategies have also puzzled a lot of people. Even when the company had structural issues, it decided to take on debt to repurchase stock and pay a sizable dividend. It continued paying a dividend through July and meanwhile, the company’s debt status got downgraded. ^[8]

For all its troubles, the company did have a liquidity position of over $900 million, including restricted cash and available credit facilities, at end of Q2 2012. Intelligent deployment of this capital has the potential to drive future growth for the company. However, without a full-time CEO, it is difficult to expect the management to identify the right growth drivers and evolve a sustainable long-term strategy. Hence, right now the priority should be to recruit a good CEO.

We would be interested in the company’s comments on these issues in the Q3 earnings conference call. As for the actual quarterly financial results, we would be surprised if the company reports a performance improvement over the previous quarter.

We have a Trefis price estimate of $3 for RadioShack, which is at a premium to the market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. Forbes Earnings Preview: RadioShack, Forbes [↩]
2. Understanding U.S. Consumer Electronics Retailing, Cognizant Whitepaper [↩]
3. RadioShack Upgrades Online and Mobile for Holiday, RIS News [↩]
4. RadioShack Q2 2012 10-Q Filing, SEC [↩]
5. Will New CEO Recharge RadioShack?, Barron’s [↩]
6. RadioShack Q2 2012 Earnings Call, Seeking Alpha [↩]
7. Why Best Buy Is Still Worth $25, Trefis [↩]
8. Is It Time To Bet On Radio Shack?, Seeking Alpha [↩]