RadioShack (RSH): A Contarian View Of Earnings

Shares of RadioShack (RSH) soared nearly 14% on Thursday after the company reported revenue growth of 6% on a 6.9% increase in same store sales. Good initial sales of digital-to-analog TV converter boxes, video games, prepaid cellphones, and AT&T Wireless (T) drove results.

But with results like these, investors need to step back and look at the bigger picture. One quarter of good results is great but, in the long run, what is RadioShack’s competitive advantage? It has small stores with pushy commissioned salespeople who make shopping less enjoyable the Best Buy, higher prices than its big box competitors, a higher cost structure, and a brand that’s quickly becoming passe.

The company reported a 10% increase in operating income, but that number was buoyed by a $4.3 million decrease in depreciation and amortization expense. Without that shift, earnings would have risen by a very mundane 3.2% on a 6% increase in sales as gross margins fell 110 basis points to 47.2% in the face of greater promotional activity and changes in the product assortment. What drove the decrease in depreciation in amortization? According to the 10-Q released yesterday, "The declines in depreciation and amortization were primarily due to our reduced capital expenditures during 2006 and 2007." Companies that drive bottom line growth by sharply reducing capital expenditures are generally not well-positioned for long-term viability. It can look great for awhile but, in the long run, not investing in your business hurts future earnings.

Still, the company’s results for the quarter are impressive given the economic environment, and management appears to be running this bad business well. There’s no shame in running a broken business well, but investors unlikely to get rich investing in one either.

The stock is currently trading at about 2.25 times its book value, and it’s hard for me to imagine what about the company is worth a billion dollars more than the sum of its assets and liabilities. The company may continue to impress for awhile, but does anyone really think RadioShack will be a force in 10 years? I just don’t see it happening, and especially not with a slash and burn approach to capital expenditures.

Zac Bissonnette