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4 Reasons To Dump This Struggling Retailer

Friday, March 7, 2014 - 1:00pm

When assessing a company's stock, many investors make it a point to check out its bonds, too. This can often provide insight into a firm's financial health and where its stock price is headed.

Keeping an eye on credit ratings is especially smart if you're thinking of buying stock in an out-of-favor company struggling to turn itself around. You certainly don't want to sink hard-earned cash into a stock based on a nice-sounding turnaround story only to find out the hard way -- by further decimation of the stock price -- the firm was a financial wreck on the verge of bankruptcy.

If they don't watch out, that's just what could happen to shareholders in one struggling retailer.

The company is the subject of much turnaround chatter. And its stock has shown the ability to post exciting returns recently, more than doubling from mid-November 2012 to mid-May 2013. After retreating over nearly a three-month period, it popped again, this time almost 60% from early August to mid-September 2013. Following another pullback, it was on the move yet again from mid-January to the end of February, rising 31% during that time.

But despite these brief, intense updrafts, the stock is still trading around $2, leaving shareholders no better off than they were in mid-November 2012. Worse, the stock could plunge far lower within a year.

One key sign of this possibility -- the status of the firm's bonds, which are rated "Caa1" by Moody's and "CCC+" by Standard & Poor's. Both ratings mean the same thing: The bonds are extremely speculative. And both are just two notches above the level where default with slim chances of recovery would be considered imminent. I think it's safe to say the stock of a firm with such severe financial issues is probably as dangerous as its bonds.

The company I'm referring to is none other than the ailing consumer electronics distributor RadioShack (NYSE: RSH). Besides horrible credit ratings, here are three other reasons not to buy into "The Shack's" turnaround or consider dumping the stock if you already own it.

Dismal Financial Performance
The March 3 earnings reports is the latest example (and the stock is down around 20% in the four days since).

For the fourth quarter of 2013, sales fell 20% to $935 million and RadioShack posted a bottom-line loss of $1.93 a share -- 12 times the $0.16 loss Wall Street expected. Since 2010, sales are off more than 8% annually, from $4.5 billion to the current $3.4 billion. During the same period, EPS dropped from $1.68 to a loss of $3.97.

RadioShack recently announced it would soon be shutting down 1,100 of its approximately 4,100 locations.

Looking back further, RadioShack hasn't grown substantially for nearly a decade -- since 2005, when sales reached $5.1 billion (a 6% increase from 2004). Since then, sales have only eroded.

Overwhelming Competition
It's hard to see RadioShack improving the top and bottom line much when it's up against such fierce competition from far stronger rivals that offer the same or similar products, often at better prices and in more convenient and varied venues. Why, for instance, would consumers make a special trip to RadioShack for things like computer products or even smartphones when they can typically get them cheaper at Wal-Mart (NYSE: WMT) or Target (NYSE: TGT) -- and do all their other shopping at that same time?

They usually wouldn't, hence RadioShack's current predicament. Competition from Amazon (Nasdaq: AMZN) and other far cheaper online retailers has obviously hurt the company, too.

Turnaround Plans Are Too Little, Too Late
RadioShack is taking measures typically seen at ailing companies. Last October, for instance, it received $835 million in new five-year financing from GE Capital and Salus Capital Partners, though this was likely its last chance to tap the capital markets. The company is attempting to rebrand, too, most recently with its humorous "The '80s called, they want their store back" Superbowl commercial and a "Do It Together" marketing campaign stressing customer service. And of course, it's closing stores, announcing recently that it would soon be shutting down 1,100 of its approximately 4,100 locations.

But to my mind, RadioShack's best attempt at survival is the testing of new concept stores, the first of which opened Jan. 10 in Lynwood, Calif. The stores are intended to provide an upgraded shopping experience with things like a modern new look, touchscreens and apps with product information, displays with in-demand brands such as Apple (Nasdaq: AAPL), Samsung (OTC: SSNLF), and HTC (OTC: HTCKF), and a do-it-yourself area where customers can plan their own electronics projects.

The problem is there are only a handful of these stores, and analysts estimate RadioShack has sufficient liquidity for perhaps another year. Assuming the new concept stores would even be successful, revamping enough of the remaining 3,000 locations to revive the company would likely be a multi-year, multi-billion-dollar project. So I'm concerned the company will run out of money well before its turnaround is complete.

Risk to Consider: RadioShack's future is very much in doubt. Current shareholders could lose their entire investment.

Action to Take --> RadioShack has been around for decades, so it's tempting to think its current situation is a chance to buy a good company cheap, then watch the stock rise by multiples of the current low price. Of course, no one can predict the future, but I'm inclined to see RadioShack more as a value trap than a profitable turnaround play.

The company has lost nearly 90% of its market value during the past three years and could be out of business in a year. Since buying the stock at this point is a huge risk, I wouldn't invest any more in it than you can afford to lose.

P.S. In our latest Top 10 Stocks report, you'll find one "wide-moat" company that has raised its dividend over 460% since 2004. Another dominates its market... has increased dividend payments 104% since 2008... and has returned 131% since it went public just over four years ago. You can learn more about these 10 stocks, including several names and ticker symbols here.

Tim Begany does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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