Two Stocks with Pervasive Pessimism

Glen is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Two Companies - One Thing in Common

Pervasive Pessimism, as I see it, is when the consensus amongst the heavyweights on a particular matter of interest is unbalanced, with additional emphasis on all of the negatives while simultaneously ignoring anything that could be seen as a positive. Best Buy (NYSE: BBY) and RadioShack (NYSE: RSH) are two companies that in my opinion are priced to have a dismal future. In fact, their price reflects, in my opinion, a future that leaves a lot of upside on the table.

The Problems with Best Buy

  1. The stock has fallen even after a buyout offer at a higher price. Richard Schulze made an offer to take the company over at a price that is much higher than the price today and management turned him down.
  2. Everyone is increasingly using popular terminology for any brick-and-mortar company amounting to "some online company's" showroom. Best Buy is frequently considered Amazon's showroom.
  3. Gross profits are set to decline. Revenues are set to decline.

The Problems with RadioShack

  1. Available evidence suggests that management has no idea what to do with their cash.
  2. Their margins have fallen dramatically, taking EBITDA in 2010 from $455M to EBITDA in 2011 to $268M to EBITDA in 2012E of around $70M. Needless to say, the market value of the company's equity has dropped from $2,000M to $228M in this same time period.
  3. The near-term outlook still is filled with landmines. On the Q3 conference call, there is no clear route to the return to previous levels of profitability. To give an idea in regards to the drop, the company has around 7300 locations. In 2010, that amounts to $5194 of EBITDA a month per store. In 2012, that amounts to $800 of EBITDA a month per store.

The Realities As They Stand Before Me

The current consensus on Best Buy is that cash flow is heading to less than zero and therefore the company finds itself universally hated by all of the smart money that is out there that seems to be in love with all the hot companies like Apple, Google, Amazon, etc. Meanwhile, RadioShack has fallen over 90% in the last couple years. RadioShack totally beefed on their dividend policy earlier this year and their buyback appears to have ridden out the wave of clueless analysis.

RadioShack is Truly a Turnaround Play.

Their numbers have been slammed and they are working to restructure what appears to be an unprofitable business exchange with Target. The price is low and the expectations are bleak but in the case of RadioShack, I see a risk profile that warrants upside but not as much as one would hope if they've experienced the 90% slide from over $20. If you are into turnarounds, this may be for you. In my case, I am interested in the easy money, and as I continued to look into the details of RadioShack to try and get ahold of a sense of where things are going I do think that their worst is likely behind them, but I have no conceptualization of how their future will do more than just stabilize. I don't like to bet on Turnarounds, so I will watch from the sidelines.

Best Buy has less Upside Potential But is the Best Buy

First things first, their dividend is sustainable and is greater than 4%. Secondly, the latest surge in stock price is coming on the heels of rumors from sources familiar with the matter that Richard Schulze, the creator of Best Buy, is looking to make a "going private" bid for the company. The price of the bid at even $7B offers significant short term upside to buyers of present at a $5.4B market capitalization. 30% in less than a year is a pretty sweet offer. The fact is that if the creator thinks that it is worth more and wants to own the entire thing, you should too. With a solid dividend, a financial profile that is actually more solid than you would think, and the exciting possibility that you're going to get bought out at a premium, this still isn't enough information for me to say that it's worth owning. The piece of information that I like to consider is "how much downside is there from here?" I would argue that the bottom is in at Best Buy at $14.50. Their operating cash flow per share is strong, coming in at over $7.50 per share now. Trading at less than 2x cash flow is insane. Buy. At this point, rejoice in lower prices, but I think that the best buys are already behind us. There is only one direction to go, up.

I think that Richard could get away with stealing this from you for $20. I figure it's worth more than that. The cash flow is there to back it up.

Glen presently has no position in any of the companies mentioned but will be buying Best Buy in the next 5 business days. Glen does not own RadioShack but will watch cautiously until he has a better sense of where things are heading and if they are heading for the better, he will react accordingly and buy if the price remains unreasonably low.

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