Does This Company Have Lots of Value, Or Is It Plummeting to Its Death?

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

Fort Worth-based Radio Shack (NYSE: RSH) has clearly fallen on tough times. The once-ubiquitous electronics retailer has been forced to lay off thousands of employees and close many outlets as large-scale changes to the industry in which it operates have rendered it increasingly unable to compete with its peers. The company has faced competitive pressures from all directions, including online retailers like Amazon (NASDAQ: AMZN), which sells many of the same products at a discount, as well as online auction sites like eBay that offer bulk deals and other innovative gimmicks. Amazon sold $61 billion worth of products in the last 12 months, compared to only $4 billion by Radio Shack.  Of course, not all of Amazon’s sales are electronics, but sales of electronics have been growing for years at the online retailer.  What's more, Radio Shack faces pressure from healthier, more nimble physical retailers like Best Buy and Wal-Mart. From a business perspective, the niche that Radio Shack occupies seems to be shrinking rapidly.

However, it is not completely clear that Radio Shack is in a terminal decline. Many of the wounds that it has suffered over the past decade are self-inflicted and might be corrected through aggressive action on the part of its management team. Investors who believe that Radio Shack can pull itself out of its current tailspin might be heartened by its rock-bottom price-to-book value of .56. Despite a recent raft of analyst downgrades, this low valuation might hint at a temporary share-price resurgence that could benefit keen-eyed investors.

About Radio Shack

Radio Shack is one of the most recognizable American electronics retailers. During its heyday, the company's stores were hailed as innovative, friendly places that provided customers with a wide range of electronic devices and equipment that could not easily be purchased elsewhere. It still operates around 4,700 stores in the U.S., Mexico and the Caribbean. Through a partnership with Target (NYSE: TGT), it also operates around 1,500 communications kiosks inside Target's big-box stores. Hopefully, Radio Shack can gain sales from a percentage of the customers that are spending $73 billion at Target annually.  Finally, Radio Shack sells most of the items that are available in its stores on its proprietary e-commerce site. Radio Shack employs about 24,000 people and lost $139.6 million on gross 2012 revenues of $4.3 billion.

Radio Shack's Situation

While the company is clearly struggling with a number of secular challenges, its price-to-book ratio of less than .6 has attracted the attention of many value investors. Of course, there is an underlying reason for this persistent undervaluation: the company had a return-on-equity metric of minus 20 percent during 2012 and continues to produce dismal returns for its shareholders. In the past three years, Radio Shack's stock price has declined from a closing high near $23.50 in April of 2010 to a closing low below $2 per share in early December of 2012. Since then, it has rebounded somewhat and now trades between $3.50 and $4 per share.

Competitors and Long-Term Outlook

In recent months, Radio Shack has been buffeted by investor dissatisfaction and analyst downgrades. In fact, the company's stock now trades above its consensus price target. In this environment, "caution" is the watchword for short-term investors who wish to play Radio Shack for a bounce, as well as long-term investors who believe that the company can turn itself around in the near future.

To reiterate, Radio Shack is not in a strong competitive position. The company faces competition from larger, healthier Best Buy, as well as various online and big-box retailers. With profit margins on electronics items dropping substantially in recent years, Radio Shack's reliance on its physical locations may well spell its doom.

From a fundamental standpoint, the company's lack of crushing debt might be its saving grace. While it does carry somewhat more debt than cash, its ratio is moderate and should not serve as a cause for concern. Although the company burned through $43 million in cash during the 2012 fiscal year, investors who believe that Radio Shack's cash hoard will save it from total collapse in the near term may well be encouraged by its low valuation.

Potential Plays

Investors who believe that Radio Shack might ultimately serve as a buyout target for a larger company like Best Buy or Target might be inclined to open a long position in the stock at its current levels. Those who agree with this sentiment in principle might insulate themselves from short-term price moves by offsetting their long plays with in-the-money covered calls or other hedging instruments. At the same time, it seems unlikely that Radio Shack would fetch more than $5 or $6 per share in a potential merger or buyout.

Obviously, the more popular Radio Shack trade would involve a short position. Investors who bet that the recent run-up was nothing more than a dead-cat bounce might do well by opening a short position above $3.50 and riding the stock down to its 2012 lows near $2. However, this is a crowded trade: at the moment, short shares represent over 34 percent of Radio Shack's total float. In fact, a short squeeze might be at least partially to blame for the company's recent market-beating performance.

In sum, Radio Shack is a distressed company that may yet offer interesting opportunities for seasoned investors. Those who believe in the company's turnaround potential could leverage its upward price momentum for further profit. Those who agree with the recent analyst downgrades might be inclined to open short positions at these somewhat elevated levels. In either case, investors must do their own due diligence before committing to such a risky and volatile stock.

Mike Thiessen has no position in any stocks mentioned. The Motley Fool recommends The Motley Fool owns shares of and RadioShack. The Motley Fool is short 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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