We downgrade our recommendation on RadioShack Corp. (RSH) to Underperform. The decrease in rating is attributable to the company’s profitability, which may suffer in 2011 due to several reasons.
The transition of Kiosks businesses from Wal-Mart Store Inc’s (WMT) Sam’s Club to Target stores will result in huge loss in operating profit. Management predicted that pressure on gross margin will continue in near future since the company is working hard to revamp its struggling electronics accessories segment and deploying wireless kiosks inside Target Corp. (TGT) stores. Precipitous fall in demand for the non-wireless category products remain a serious concern for the company.
Recently, RadioShack announced that its operating income from the Kiosks segment will decline by $10 million – $15 million in 2011 due to closure of wireless kiosks at Wal-Mart’s Sam’s Club locations. The existing contract with Sam’s Club will come to an end as of March 31, 2011, with the transition period ending on June 30, 2011. By mid-2011, all the Sam’s Club Kiosks will move to Target stores.
While Sam’s Club Kiosks are well established business centers of RadioShack, the newly developed Target store Kiosks are yet to reach maturity and required promotional activities. At present, Target stores Kiosks generates an EBIT margin of hardly 4% compared with huge 12% of the Sam’s Club Kiosks. We believe RadioShack’s full year 2011 profitability will be adversely affected.
A major near-term concern for RadioShack is the significant decline of its gross margin. In the third quarter of 2010, gross margin was 45.4% compared with 47.6% in the prior-year quarter and 47.5% in the previous quarter.
Management cited precipitous decline of electronics accessories business and an unfavorable product-mix toward low-margin mobile handsets, which are 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 stores.
Additionally, we believe RadioShack is facing increasing competitive pressure from other large retail stores, online shopping stores and some mobile carriers, which directly sales handsets to customers. Increasing competitive threats from several fronts may result in lower wireless sales going forward.