Tune in to This Turnaround

04/10/2008 12:00 am EST


George Putnam

Editor, The Turnaround Letter

George Putnam, editor of Turnaround Letter, says RadioShack is in good shape operationally— yet it’s cheap because of fears about the economy.

RadioShack (NYSE: RSH) traces its roots back to a store that opened in Boston in 1921 catering to ships’ radio officers and ham-radio operators. The company evolved over the years into a broad-based retailer of consumer electronics. Today it has more than 6,000 locations in the United States, Mexico, and several other countries.

The company flourished during the tech-heady 1990s, and the stock peaked above $79 in December 1999. Then results leveled off, and the stock began a long slide to a low of $13.73 in July of 2006. To add to the company’s woes, it was discovered that the chief executive officer had fabricated a portion of his resume. He was fired, and the board brought in Julian Day, a veteran of turnarounds at Kmart, Sears, and Safeway, to run the company.

Day responded by cutting costs and closing underperforming stores. Results improved, and the market responded by pushing the stock up to $35 by mid-2007. Results have continued to improve since then, but skittish investors, concerned about a possible recession, have driven the stock back down near its 2006 lows.

Usually you have to get in early on a turnaround to maximize your profits, with the risk that you may be too early. In this case, the market is giving us the unusual opportunity to get in late—with the turnaround already well established but the stock still near its lows.

RadioShack has many of the features we like to see in a stock. It has one of the most widely recognized brand names in the electronics business. It has strong management with a well-thought-out strategy to improve results. And it is generating good cash flow: The company had free cash flow of $300 million in 2007, which it used to pay off debt and buy back stock.

By most valuation measures, the stock looks quite cheap. It is trading for about nine times 2007 earnings and about four times EBITDA (earnings before interest, taxes, depreciation, and amortization, a widely used measure related to cash flow), both very low for a profitable retailer.

The one negative for RadioShack is that revenues have declined over the last couple of years as management has focused more on cutting costs and restoring profitability. Now that the house is back in order, management can work on growing revenues again.

We believe that RadioShack’s stock will be pushed higher by continued improvements in profitability. But the company could also be an acquisition target. With its low valuation and relatively small market capitalization, RadioShack could be attractive to a larger retailer that wants to expand its presence in consumer electronics or perhaps to an electronics manufacturer that wants a retail outlet.

While the market has given us a second chance to profit from the company’s turnaround, we may not get another one. We recommend buying RadioShack stock up to $23. (It closed above $15 Wednesday—Editor.)

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