We downgrade our recommendation on RadioShack Corp. (RSH) to Neutral. Major near-term concern for RadioShack is the significant decline in its gross margin. In the third quarter of 2010, gross margin was 45.4% compared to 47.6% in the prior-year quarter and 47.5% in the previous quarter.
Management cited the precipitous decline of the electronics accessories business and an unfavorable product-bias towards low-margin mobile handsets as the primary reasons for this poor margin. Importantly, RadioShack announced that this trend will continue in the near future due to revamping of the core retail electronics segment and large-scale deployment of wireless kiosks inside Target Corp. (TGT) stores.
RadioShack is facing intensifying competition from larger rivals like Best Buy Co. Inc. (BBY) and Wal-Mart Stores Inc. (WMT). Best Buy is gradually rolling out small format mobile stores. These stores are mainly located in such shopping malls which are traditionally RadioShack territory. The company is expected to open 1,000 mobile locations by end -2010.
On the other hand, Wal-Mart has tied up with TracFone for a low-price pre-paid wireless service and also raised its mobile phone sales endeavors. RadioShack is also facing stiff competition from online retailer Amazon.com Inc. (AMZN).
Nevertheless, RadioShack is one of the most experienced and trusted consumer electronics specialty retailers in the U.S. We remain optimistic about the company’s large, profitable store base and its exposure to the wireless communications business.
After completing a pilot project, management has recently taken a strategic decision to roll out Kiosks for wireless products in a majority of 1,700 discount stores of Target Corp in mid-2011. This mobile service called “Bullseye Mobile” started rolling out from mid-August 2010.
RadioShack’s average ROE for trailing twelve month is 21.3%, significantly higher than the industry average of just 14.8%. We expect the company’s Return on Invested Capital and free cash flows to increase in the future quarters due to the massive boom in the wireless industry.
RadioShack has re-launched its “The Shack” brand of retail store chain and emphasizes wireless technology to stay aligned with future trends.