RadioShack’s Stock: A Deep Dive After CEO Departs

The following is an excerpt from a report compiled by Michael Pachter of Wedbush Securities.

Last week, RadioShack (NYSE:RSH) announced that CEO Jim Gooch agreed to step down, effective immediately. Last Tuesday, shares of RadioShack were removed from the S&P MidCap 400 index, and shares slid 16% as a result. We believe Mr. Gooch’s termination was unrelated and in process for several weeks, as the company appears to be in a poor position to revive its flagging sales, and we believe Mr. Gooch had placed the company on the wrong path. Executive Vice President and CFO Dorvin Lively will act as interim CEO while the board searches for a permanent replacement.

Mobility declines in 1H portend difficult times ahead. We believe that RadioShack’s core products drive foot traffic in its stores, leading to incremental Mobility sales, and as competitors have increasingly offered similar products at lower prices, RadioShack’s foot traffic has continued to decline. In our view, people go to RadioShack with the intention of purchasing a core product, and some end up buying a cell phone;  we do not believe that RadioShack is a destination  for cell phone purchases. RadioShack is a destination for CE, which is clearly an increasingly commoditized business, and one in which RadioShack clearly cannot compete without significant discounting. As fewer consumers have visited RadioShack for its core products, sales of its Mobility and Signature products have suffered. While Target Mobile centers drove revenue for Mobility and offset store declines in Q2, margin erosion from this mix shift severely impacted profitability, and we expect profits to remain elusive until the company rationalizes its footprint and product offering.

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We do not believe the rebranding effort is driving incremental traffic. The company has been advertising more heavily in Q3 to highlight its mobile offering (impacting profitability further), but we do not believe that the campaign has caused consumers to look to RadioShack as a destination to activate their mobile phones. RadioShack also began to increase spending on employee training to enhance the customer experience, and we remain skeptical that this will be effective over the short term. While some portion of increased store-level and advertising spending should be offset by decreasing corporate level SG&A, we believe the rebranding is too late and likely to be a net incremental cost.  In our view, additional spending will simply drive incremental losses.  We think this is the primary reason for Mr. Gooch’s termination.

Margin deterioration will likely persist into Q3. We expect further margin erosion in Q3 due to the mix shift towards lowermargin smartphones and mobile devices (with particular emphasis on the iPhone) in company-owned stores, compounded by the Target expansion due to its inability to sell high-margin accessories along with post-paid wireless phones.

We expect significant losses for 2012 and 2013. The company expects the factors that have led to declines over the past few quarters to continue to depress earnings throughout 2012, with difficulty easing in Q4. We expect further declines due to a challenging mobility margin profile, as the company shifts toward a higher mix of low-margin smartphones. Also, as the company continues to expand its presence in Target stores its margins are further compressed due to its inability to sell accessories along with post-paid wireless phones. Furthermore, the company has begun a low price guarantee for mobile phones. While we expected this to help draw incremental traffic in Q2, it appears not to have materialized. Given that the low price guarantee is clearly not compensating for the additional margin pressure, we expect it to contribute to further losses in Q3 and beyond.

In our view, management needs to revisit its core branding idea of ubiquity, particularly in this age of online and comparison shopping. We strongly believe that the company needs to begin rationalizing its total footprint, and in particular, believe that it should be closing underperforming domestic stores and possibly some of its underperforming Target Mobile centers, particularly as it grows its Mexican store base and as it begins opening new stores in Southeast Asia and China.

Reiterate our UNDERPERFORM rating and $1.00 12-month price target. We continue to expect growing losses from declining CE sales, and continued margin erosion, compounded by an ill-advised strategy to invest in growth. Our price target reflects our best guess at the brand equity and going-concern value for the business (around $300 million), net of the company’s net debt.

Risks to attainment of our share price target include changes to the macroeconomic outlook, variability in new product release timing, the company’s ability to maintain its dividend should earnings continue to decline, the effects of competition from other consumer electronic and big-box retailers and changes in consumer demand for consumer electronics.

Michael Pachter is an analyst at Wedbush Securities.

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