Which of These 3 Underdogs Has the Best Chance for Success?

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

Companies that don't change voluntarily will inevitably be changed by the market. Some companies that ruled the 1990's are down significantly today and their fate is in question. While some companies can fix themselves, others appear doomed because their past dominates their present. Other companies just survive and don't strive to be the best in their industry.

The following 3 household-names are now underdogs in their industry. These are names that are not at the top of anyone's wish list. However, one of these underdogs has the potential to go much higher in share price - sooner rather than later.

Rite Aid

Less than a year ago shares of Rite Aid (NYSE: RAD) and its 4,615 stores were trading under $1. Although the retail drugstore chain is up nearly 200% since this past December, the stock is still down over 90% from its pre-millennium highs. Most of the declines were due to negative net income for much of the past ten years. In fact, Rite Aid has an average quarterly net income of -$200 million for the past five years. The recent gains are credited due to the three consecutive quarter streak of positive net income of $62, $123, and $90 million, respectively.

There is no mystery to Rite Aid’s comeback, especially with the growing competition from Walgreens, CVS, and many of the major grocery store chains having their own pharmacies that are able to serve the same customers. Basically, Rite Aid has been able to control costs finally, and after over a decade of negative quarterly profit margins, they are now seeing them turn positive coming in at 1.42% in the most recent quarter.

One other big change, which might seem obvious in hindsight, is their loyalty card program. No different from many perks programs of grocery stores, gas stations, and other business sectors, this program helps generate repeat customers. It gives an incentive for customers to get into the store, which was hard to do prior to the program. Store remodeling initiatives have been well underway with 108 stores completed in the first quarter for a current total of 905. Short sellers are also turning away from the once bankruptcy-destined company, as shares sold short fell by 15% to 37 million of the 910 million outstanding shares.

RadioShack

Similar to Rite Aid, RadioShack (NYSE: RSH) is down over 95% from their pre-millennium highs. Unlike Rite Aid, though, there hasn’t been a bounce back, unless you count the recent speculation in the past couple of weeks of the company possibly trying to sell itself. As a company, there have only been disappointing program introductions and quarters weaker than the previous.

Quarterly profit margins have gone from being 5% just five years ago to now -5% today. In the most recent quarter, net sales and operating revenues saw 7% declines. Making up the declines was the 7.9% drop in mobile sales and a 25.3% plunge in consumer electronics which account for laptops, digital music players, TVs, GPS, and cameras – basically what RadioShack is, outside of the hard-to-find accessory department.

Like Rite Aid, RadioShack has been in the process of closing locations. In the past year, locations have declined to 5,598 from 7,272. However, with 8 of the last 9 quarters seeing declining same-store sales, it is clear that with the store reduction so far, they still can’t turn a profit. Nevertheless, the fact that nearly one-third of outstanding shares are short can produce quick gains though a short squeeze if company sale rumors continue.

Denny’s

With a stock appreciation of over 138% the past five years and up over 23% year-to-date, Denny’s (NASDAQ: DENN) at a glance looks like anything but an underdog. However, the 1,690 locations and counting restaurant chain appears to have some skeletons in the closet, which has caused it to significantly under-perform its peer group of 22 companies for several years including Bob Evans and Cracker Barrel.

First, quarterly revenues have been trending linearly downward the past five years, going from $189 million in 2008 to $114 million this year. Questions arise as to how a company dropping this much in revenue is able to have nearly consistent quarterly net income during this same time frame. Some say questionable cash flows while special tax benefits like that in the fourth quarter of 2011 explain that monster $92 million quarter – despite a drop in actual restaurant sales.

Denny’s has been morphing into a 90/10 restaurant company with 90% of the locations being franchised while the rest remain company owned. Three big benefits of this include less reliance on outside funding, reduced need for oversight management, and less risk since franchise owners have their own money at stake in making their restaurant work.

<img alt="" src="http://media.ycharts.com/charts/8e9e6db5fd771cb7cf8fdc1ccefde5e4.png" />

RAD Total Return Price data by YCharts

Foolish verdict

RadioShack looks like the battery ran out years ago. Some say that competition from online competitors like Amazon took business away. In reality, it also competed against itself. Both of its mobile phones and big electronic hardware segments saw huge drops recently which leave its accessories segment left. The problem is that accessories are low-price products with slim margins. While accessories have always sold consistently, taking losses from the other segments ruins the bottom line. Customers aren’t going to RadioShack to buy expensive computers or TVs, and would rather visit their cell phone carrier’s store to buy a new phone.

Denny’s looks like a buy right now since the stock has been trending up for the past ten years. However, it is hard to explain where the money is coming from to account for net income when they haven’t been able to halt the decline in quarterly revenues. Additionally, the fact that IHOP is already 99% franchised – near Denny’s long-term goal - it looks like Denny’s will work to reach its business goals before it can turn revenues around.

A year ago Rite Aid would look to be the worst of these 3 underdogs. Now after a few company initiatives, the company looks like it did a complete 180 and looks be the winner. Producing real income for the first time in years, the stock has the potential to go much higher despite the huge run-up so far – especially considering its competitors Walgreen and CVS have enterprise values that are over 20x that of Rite Aid.

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Michael Carter has no position in any stocks mentioned. The Motley Fool owns shares of RadioShack. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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