Somehow I missed this early in the week. Hat tip to Todd Sullivan’s - ValuePlays:

Apparently on Monday there was heavy call buying in RadioShack (RSH) - ironically a day I was writing puts on the name. Rumor is that Dell (DELL) is kicking the tires. It would be an easy way to get into retail in a bigger way.

Here’s a video discussing the rumor.

Anyhoo - my original thesis was that RadioShack’s valuation is cheap, at ten or eleven times earnings. My preferred measure, the free cash flow yield, is a downright juicy 14.3%. With that kind of cash flow yield, RSH could generate double-digit returns even if cash flow declined 4.3% per year. With five-year Treasuries yielding just 2.5% the declines could be even larger and still earn investors the typical risk premium that would be expected for holding stocks.That and the fact that there seems to be solid technical support contributed to my writing put options at $15 each of the last two months.

Disclosure: At time of publication, William Trent has written put options against shares of Radioshack (RSH).

This article is a reprint of my March 10, 2008 RealMoney column

• I don’t expect RadioShack to grow.
• But it should be worth buying as long as they can limit their cash flow declines to 5% or so annually.
• Combined with a put-write strategy, it looks even better.

RadioShack (RSH) is a company investors love to hate, and it isn’t hard to see why. Stocked full of stuff you occasionally need but often find elsewhere, it represents the unsexy part of consumer technology – wires, batteries and cables that you forgot to pick up when you got the HDTV or game console at your local Circuit City (CC) or (more likely) Best Buy (BBY).

What’s more, RadioShack’s 4,400-odd company-owned stores, on average, sold 6.7% less stuff in the fourth quarter of 2007 than they did in 2006. This is an improvement from the full-year same-store decline of 8.2%, which is partly attributable to the fact that 525 stores have been closed since year-end 2005. Many of these, presumably, were the worst-performing ones. Having fewer of the really bad ones open for the last 12 months will contribute to improving same-store figures.

Now that the low-hanging fruit has been picked, investors need to figure out whether what remains is worth climbing what could be a rickety ladder. Most investors tend to shy away from companies that aren’t growing, and generally flee from those that are shrinking. Still, even shrinking companies are worth something, and investors can be rewarded if they pay the right price.

The valuation is certainly cheap, at ten or eleven times earnings. My preferred measure, the free cash flow yield, is a downright juicy 14.3%. With that kind of cash flow yield, RSH could generate double-digit returns even if cash flow declined 4.3% per year. With five-year Treasuries yielding just 2.5% the declines could be even larger and still earn investors the typical risk premium that would be expected for holding stocks.

With the question thus changed from whether RadioShack can ever grow again, to how much shrinkage is currently priced in, the analysis becomes a bit less sticky. For this, I think I’d accept a return in line with that of RadioShack debt – which reflects the company’s relative risk and allows for a modest premium based on the more favorable tax treatment of equity returns.

RadioShack’s May 2011 note is currently yielding about 7%. To generate equity returns higher than this, RadioShack will have to limit its free cash flow declines to 8% per year – in other words, they can’t get any worse.

RadioShack attributed the same-store sales weakness in 2007 to “a decline in postpaid wireless sales for our two main wireless carriers.” Wireless sales account for a third of RadioShack’s business and those two carriers are Sprint (S - Annual Report) and AT&T (T - Annual Report). Sprint’s performance has been pathetic, while AT&T is relatively weak in the Northeast, particularly RadioShack’s largest market – New York City. The contracts with AT&T and Sprint don’t expire until 2015 or later, so there isn’t much hope for a carrier shake-up. On the other hand, Sprint is now so bad that incremental further declines may cease to register.

Investors seem to be picking up on the potential value, as the rally following the latest earnings report has given the shares some fragile support. Given the state of the economy and particularly RadioShack’s wireless exposure, I think the company will eventually stem the bleeding to within my acceptable range, but probably not this year.

As is often the case, though, I think the doubt can be addressed by using a put-write strategy to enhance returns and further reduce the potential entry point. As I write this, April $15.00 puts are selling for $0.80 – a 5.3% premium on money that is risked for about six weeks. If the stock declines and the options are exercised, the effective entry price would be lowered to $14.20 – a price that would boost the effective free cash flow yield to 17.8% and increase the margin of safety to permit an acceptable return even with annual free cash flow declines of 10%.

That starts to look like a risk worth taking.

Disclosures: William Trent has written put options against the shares of RadioShack (RSH)

Our earnings preview for Garmin (GRMN - Annual Report) said it “shouldn’t need a big surprise to move the stock from this level.” Today the company reported earnings:

First Quarter 2007 Financial highlights:

– Total revenue of $492 million, up 53% from $322 million in first quarter 2006

– Earnings per share increased 60% to $0.64 from $0.40 in first quarter 2006; excluding foreign exchange, EPS increased 37% to $0.59 from $0.43 in the same quarter in 2006.

These results compared to consensus expectations of $0.59 on $499 million in sales. So the stock did indeed move on a not-big surprise, albeit one in the opposite direction from which we implied. The company did not change its prior guidance, saying:

We remain optimistic about the future success of our business and our ability to serve customers and distributors around the world. We anticipate overall revenue to exceed $2.5 billion in 2007, and earnings per share to exceed $2.70 assuming an effective tax rate of approximately 13 percent. We anticipate automotive/mobile revenues to grow faster in 2007 than we earlier anticipated, and continue to expect declining operating margins due to product mix and a continued transition toward mass market levels. We intend to provide a formal update to our fiscal 2007 financial expectations during the Q2 2007 earnings conference call.

Unfortunately, analysts were already ahead of those expectations, calling for $2.81 in EPS on $2.54 billion in sales. Without a significant surprise in Q1 or a significant surprise forecast for Q2, the estimates are starting to look a bit out on a limb.

Add this data point to the ones provided by Royal Caribbean (RCL), Plantronics (PLT), Radio Shack (RSH) and Circuit City (CC) that consumer spending may be slowing.

Early in April we noted the disparity between the market reactions to sales reports from Circuit City (CC) and Best Buy (BBY). We speculated that the market favored Circuit City’s poor performance because the worst appeared over and management was getting down to nuts and bolts. If that was indeed the impetus for the positive reaction, it proved premature.
Circuit City issued a press release yesterday adjusting its previously reported numbers for some accounting matters. Buried in the press release was this revision to the previously issued guidance:

For the month of April, the company experienced substantially below-plan sales, primarily related to the large flat panel and projection television categories. Due to this trend, the company now expects a loss from continuing operations before income taxes of $80 million to $90 million for the first quarter of fiscal 2008. In light of uncertainties in the current operating environment, the company is withdrawing its previously issued guidance for the first half of fiscal year 2008.

Assuming business trends improve and the transformation efforts are effective, the company forecasts fiscal 2008 earnings from continuing operations before income taxes (EBT) as a percentage of consolidated net sales at the low end of the company’s previously guided range of 1.4 percent to 1.8 percent. The company will continue to monitor general business trends as well as the effectiveness of its transformation efforts and expects to provide an updated fiscal 2008 forecast when it releases results for the first quarter of fiscal 2008 in June.

So the old “worst case” is the new “best case.” The question now becomes whether the weakness is indeed specific to Circuit City. Recall that Radio Shack’s (RSH) positive move on Monday resulted from better than expected cost savings.  The revenue performance was atrocious. Circuit City makes for a second awful report. If we see the same from Best Buy, those who have long been calling the death of the American Consumer may finally be proved right.

We’ve heard about the Business Week indicator, but now that Radio Shack (RSH) reported earnings we may have to devise an Onion indicator.

RadioShack Corporation (NYSE: RSH) today announced net income of $42.5 million or $0.31 per diluted share for the quarter ended March 31, 2007 versus net income of $8.4 million or $0.06 per diluted share for the quarter ended March 31, 2006. First quarter net income was favorably impacted by improved gross margin, a reduction in selling, general and administrative (SG&A) expenses and an increase in interest income when compared to the prior year period.

The results for the quarter were impacted by two unusual items. The negative impact of costs related to employee separations included in SG&A expenses ($8.5 million pre-tax) was more than offset by an increase to gross profit ($14.0 million pre-tax) associated with the recapture of federal telecommunications excise tax. The prior year period’s results included a charge for impairment of fixed assets which reduced the company’s 2006 first quarter pre-tax income by $8.9 million. The items noted above increased earnings per share in the March 2007 quarter by $0.02 and decreased earnings per share in the March 2006 quarter by $0.04.

Analysts were expecting the company to earn $0.14 on $1.04 billion in sales. While the earnings were better than expected due to the margin improvements, the sales did not live up to expectations.

First quarter 2007 comparable store sales were down 9.2% versus the prior year. Total sales decreased in the first quarter of 2007 to $992 million, down 14.5%, from total sales of $1,160 million for the previous year. The declines in the postpaid wireless business continue to impact both the comparable store and total sales results. In addition, total sales were impacted by 506 fewer company-operated stores and kiosks when compared to last year.

Apparently, when companies reach the point of parody things may be as good or as bad as they are going to get.