Buy Aaron's Over Floundering Best Buy, RadioShack

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

"Struggle" has always seemed to be the name of the game for consumer electronic retailers. From Circuit City's Chapter 11 filing to Best Buy (NYSE: BBY) and RadioShack's (NYSE: RSH) financial woes, business has been tough. Sometimes the lesser known players promise the greatest upside. While I don't recommend buying Best Buy and RadioShack, I recommend buying Aaron's (NYSE: AAN)

Best Buy & RadioShack

Richard Schulze, the founder of Best Buy, gained board approval to proceed with taking over the business. The friendly buyout has enabled Schulze to gain control of the firm's financial statements for better due diligence. He has earlier floated a $8.5 billion takeover offer and claimed to have private equity firms on his side, along with a "highly confident" position from Credit Suisse on raising the necessary debt financing to close the deal. The founder now has around 40 days to reach an agreement, and, if management rejects the offer, he must wait until January. An offer directly to the shareholders would follow if the second offer were also rejected.

The stock is currently worth $6.1 billion, but it is highly uncertain where Schulze may go with the next bid. Over the last three months, the stock has fallen by 8.1% under dying excitement. On a fundamental level, the business may sound cheap at only 6.1x forward earnings, but the business is failing, and analysts lean towards the "sell" side.

ROE is in the negative double-digits while ROA and ROI are both in the low single-digits. The $6.1 billion retailer generated $863 million in free cash flow for the TTM ending 2Q12. This compares to $1.6 billion generated for the TTM ending May 31, 2011. Accordingly, although free cash flow has been on a precipitous decline, it sill offers a high yield against the market cap. With a dividend yield of 3.8%, many investors might be tempted into buying a stake. I, however, recommend avoiding the business and going for stocks were upside is more certain…

That means, RadioShack, is a "no go." The electronics "junk store" (sorry, but it's kind of true) is rated a 3.4 out of 5 on the Street where "5" is a "sell." Earnings have improved only 3.8% annually over the past 5 years, but they are now expected to decline 5.5% annually over the next 5 years. Liquidity is poor, and operations continue to flounder - denying the business an opportunity to turnaround.

Free cash flow for the TTM ending 2Q12 was just $71 million versus $119 million in 2Q11 (ttm). Shareholder value has, accordingly, been on a steady but fast decline - erasing more than three-quarters of the stock from the 52-week high. Unless you are a takeover or turnaround artist, this is not the stock for you - and, even if you are, there's too many downside factors that will weigh against an attractive case for suitors.

Aaron's

Aaron's is a brand that you may have never heard of before. On one hand, this could mean that you would be getting involved in a obscure business. On the other hand, this could mean that you are getting involved in something that will become a recognizable brand in a few years. Fortunately, Aaron's looks fairly compelling at a respective 13.2x and 12.7x past and forward earnings.

Analysts currently expect EPS to grow by 12.9% annually over the next 5 years. This is just 270 bps greater than what was achieved during the 5 years surrounding the depths of the worst macro period since the Great Depression. Assuming that the company merely grows EPS by 12.9% over the next 5 years, 2016 EPS would come out to $3.22. At a multiple of 16x, the future value of the stock would be $51.52 - around double the current valuation. Discounting backwards by 10% yields a present value of $32. This is not at an incredible premium to the current valuation, but is enough to justify making a speculative investment.

Aaron's sells a variety of products ranging from computers and TVs to household appliances and furniture. They carry a variety of different bands and manage 47 HomeStart stores plus 38 Sales & Lease stores. Accordingly, there is great potential for the company to expand through buying new units. It has around $109 million cash in hand; but, given how good sales have been, the company should not have trouble raising debt for further increases in scale. Results during 2Q12 and 1Q12 were solid with the later beating consensus by $0.04 on EPS of $0.60. Accordingly, I recommend opening a position in the electronics retailer as the low bar set for growth is exceeded - a process that will not only result in earnings growth but also an expansion of their price multiple.


TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Best Buy and 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.If you have questions about this post or the Fool’s blog network, click here for information.

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