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Why The Shack may never get back into the black

Best Buy and J.C. Penney were considered, for good reason, to be the U.S. retail disaster stories of 2012. But there was another company that handily underperformed both.

RadioShack Corp. had a nifty 77 per cent decline in its share price last year. It was among the worst performing stocks in the entire Russell 3000 Index of U.S. companies.

RadioShack is still around? Make no snarky comments about dweeby customers buying parts for radio-assembly kits: RadioShack, rebranded as "The Shack," has moved solidly into the modern consumer electronics space, with the majority of its sales coming from cellphones, tablets and the like.

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As it turns out, that is a large part of the problem. While the classic RadioShack electronica has sold well, it's the margin-sapping cellphone business that seems to be the chief culprit in dragging the company down. Yet management plows ahead with cellphones as the core of the company's plan. A close look at the company should serve as a warning: While there may be some profitable headline-driven spikes in the share price in 2013, the long-term prognosis is that The Shack may never get back into the black.

Now, to be sure, the shares, trading at around $2.20 (U.S.) apiece, have a certain appeal to dumpster-diving value investors. The company's market capitalization has fallen to about $220-million; it also has about $200-million in net debt (total debt of $750-million offset by about $550-million in cash). That adds up to an enterprise value of just more than $400-million. That means RadioShack is trading for less than half the $850-million value of the inventory on its books at Sept. 30. Or, a multiple of 0.3 on a price-to-tangible-book-value basis. (There are only about five cheaper stocks in the Russell 3000 by this measure, per Standard & Poor's Capital IQ.)

There is good reason for this, however. The company has posted net losses in each of the first three quarters of 2012 and over that period has lost a total of $76-million, on $2.96-billion in sales. The third-quarter results featured a 3.1 per cent year-over-year sales decline, including a 2.9 per cent decline in its mobility (phone) segment. The greater amount of phones in the sales mix, however, caused gross margins to drop by nearly seven percentage points, year over year.

"By increasingly relying on wireless," says analyst Anthony Chukumba of BB&T Capital Markets, "RadioShack has less and less control over its own destiny. Simply put, the company's interests are not necessarily always aligned with its wireless carriers or handset providers, and RadioShack lacks the necessary leverage to influence decisions that ultimately impact its financial performance."

Michael Pachter of Wedbush Securities says other consumer electronics drive RadioShack's diminishing traffic. "In our view, people go to RadioShack with the intention of purchasing a core product, and some end up buying a cellphone; we do not believe that RadioShack is a destination for cellphone purchases." Best Buy represents a major challenge, as do the 8,000 carrier-owned stores in the United States.

Indeed, the worst sign for the stock is that the best possible near-term news would be if RadioShack sobers up and announces the closure of a major chunk of its 4,000-plus stores. (RadioShack Canada became The Source several years ago and is now owned by BCE.)

If the company can unwind its partnership with Target, where it's managed to lose $38.2-million selling mobile phones in 1,500 Target kiosks, it could add 30 cents to 40 cents to its annual earnings per share, estimates Michael Lasser of UBS.

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The longer term? Well, several analysts have "bear" scenarios in which sales declines accelerate, margins keep contracting, and losses pile up, with the shares heading to 50 cents, or even zero. "It appears to us that RadioShack is destined to continue to lose money, and we believe that the company's spending on rebranding, training and international growth will exacerbate its problems in the near term," says Mr. Pachter. "We do not see a light at the end of this tunnel."

The old joke – apropos here – is that the light is actually an oncoming train. Is RadioShack on track? Not in the way management thinks.

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