(By Mani) RadioShack Corp. (NYSE:RSH) is in between a rock and a hard place as the second quarter results reflect the consumer electronics retailer's ongoing challenges.
The company struggles to remain relevant to consumers, faces ongoing margin pressure from greater sales of Mobility products and its relationship with Target Corp. (NYSE:TGT), and grapples with its liquidity needs.
Competition in the mobile category continues to ramp up as rival Best Buy Co., Inc. (NYSE:BBY), Staples, Inc. (NASDAQ:SPLS) and hhgregg, Inc. (NYSE:HGG) have become more aggressive in the category. Best Buy has been the most aggressive, rolling out stand-alone Best Buy mobile throughout the US, including in malls where RadioShack has a presence.
The increased competition comes at a time when the mobility category has grown in importance to RadioShack; which represents more than 50 percent of sales now. A higher portion of the company's mobile business is coming from the Apple iPhone and Target Mobile business, which has contributed to sharp margin declines in the past few quarters.
The Apple iPhone has lower margins than comparable phones, while the Target Mobile business mix is primarily composed of postpaid wireless sales and offers limited higher margin accessory sales. The Target roll out has continued to perform below company expectations and its 2011 10K filing shows that the loss associated with Target Mobile centers increased by $17 million from last year.
Meanwhile, the consumer electronics (CE) product cycle continues to suffer from a lack of innovation in non-Apple products. CE sales have declined more than 20 percent in the past three quarters, and the weakness is expected to continue in the next few quarters with heavy competition from Amazon.com, Inc. (NASDAQ:AMZN).
So, on one end, RadioShack faces challenging sales environment, which is leading to lackluster comps even as the company adds more doors through its Target initiative. On the other hand, the retailer's smartphone business -an area where they are seeing some sales growth, is a lower margin business.
Through the Target partnership, RadioShack primarily sells postpaid wireless services, which carry lower margins than the corporate average. Given the unprofitable nature of this relationship, the deal could eventually dissolve.
"If the arrangement is dissolved, it could be positive for RadioShack as it could eliminate this lower margin piece of its business. Alternatively, RSH risks potentially losing some of the mobility customers it acquired through its presence at Target (assuming this retailer retains its mobile offerings)," UBS analyst Michael Lasser said in a client note.
In addition, RadioShack suspended its dividend as a way to preserve cash ahead of the upcoming debt maturity of $375 million in August 2013. As of the end of the quarter, the company appears to have ample liquidity at the moment with roughly $520 million in cash and about $400 million under its revolving credit facility, however, the continued gross margin pressure is affecting their free cash flow generation.
"We see these challenges persisting, with cost cutting not providing much relief. RadioShack's balance sheet is in reasonable shape, but the dividend cut hurts," Deutsche Bank analyst Mike Baker said in a client note.
The company's revenue mix is likely to move more towards mobility in the coming quarters as sales from their Target kiosks drive essentially all of their sales growth. However, the Target business is dominated by post paid handset sales, not higher margin prepaid or accessories, so increased sales here will mix down total company margins further.
There is one more issue for the company. Its cost cutting opportunities are limited as in order to drive higher attachment rates of accessories in their RadioShack stores, it needs to invest in training and personnel.
Outside of a macro or product cycle driven rebound in consumer electronics sales, the best solution for RadioShack is to make good on its plans to sell more, higher margin accessories. Renegotiating the terms of its Target deal to share in this part of the business along with the lower margin hand set business would also help.
"But, attaching more higher margin accessories to lower margin hard goods is not a new strategy for RSH, so we are unsure of why it would be much more successful this time around," Baker said.
For the second quarter, RadioShack posted a net loss of $21 million, compared to a profit of $24.9 million in the previous year. On a per share basis, loss was $0.21, in comparison with earnings of $0.24 per share last year. Net sales and operating revenues rose 1.2 percent to $953.2 million. Analysts, on average, expected earnings of 3 cents per share on revenue of $970.35 million for the quarter. Comparable store sales were essentially flat.
RadioShack, a leading retailer of consumer electronics and services, operates about 4,700 stores and nearly 1,500 kiosks in the United States. Shares of the company have plunged 75 percent year-to-date, and has underperformed gains of 6 percent in the S&P 500 and most other leading stocks during the past few quarters. Out of 21 analysts covering the stock, 15 of them prefer to remain on the sidelines with a "hold" rating and five analysts recommend investors to "sell" the stock.