As a deep value investor, I am constantly on the hunt for a bargain — the proverbial “50 cent dollar.” This sometimes means I’m buying names that no one else wants, companies that have admittedly seen better days. It is, indeed, a risky business and not for the faint of heart.
I sometimes refer to it as “buying ugly.” The practice does not always bear fruit, but can be very rewarding when you are right.
You know the story: A formerly solid company puts up some bad numbers, or perhaps is beginning to look like a dinosaur for the times and the extinction process has begun. The stock gets hammered as more investors head for the sidelines, and, before you know it, the company’s market cap is a fraction of its former self. Sometimes, the damage done is warranted. I look for situations where there has been an overreaction, at least in my view.
It’s no secret that the electronics retailing business has been extremely challenging in recent years. We’ve seen big chains like Circuit City go bankrupt. It is a highly competitive business, and the brick-and-mortar stores are having difficulty at the hands of online retailers like Amazon.com (AMZN). We’ve seen Best Buy (BBY) closing stores and laying off workers. Its stock is down 30% in the past year.
The story has been worse for RadioShack (RSH), whose shares have fallen off a cliff. The stock is down 68% in the past year and 58% year to date. This name once changed hands for more than $70 a share, and has fallen below $4.
Truth be told, the company’s best days are, indeed, behind it. But that’s not the issue. The question is whether RadioShack shares are worth more than their current $3.91 price. Even the best companies become overvalued, and sometimes the worst are undervalued. This is not a bet that the company will be restored to its former glory, but rather that its stock, in all its ugliness, is undervalued at current levels. Welcome to the warped mind of a deep value investor.
Admittedly, I did not like RadioShack shares at $7, when it first hit my radar last March. But when shares fell below the company’s net current asset value — a deep value technique devised by Ben Graham that’s calculated by subtracting total liabilities from current assets — I took an initial position. Shares currently trade at 1.01 times NCAV. That’s an indication that shares are either very cheap or that the company is headed for the scrap heap.
Despite its challenges, RadioShack still has a decent balance sheet. The company ended last quarter with $566 million, or $5.67 per share, in cash. It also has $675 million in debt, $375 million of which matures in 2013, while the rest matures in 2019.
As for its monstrous 12.6% dividend yield, I have very little faith that it will be maintained. In fact, I am expecting that it will be eliminated altogether as the company conserves its cash. I did not take a position in the stock for the yield.
While the first quarter was rough, and the company badly missed earnings estimates, RadioShack has still been able to generate 64 cents in free cash flow per share in the trailing 12 months. The market does not believe that will continue. As for the analyst community, the consensus calls for $4.49 billion in 2013 revenue and earnings per share of 38 cents.
Warren Buffett might describe investing in distressed companies such as RadioShack as “cigar-butt” investing. I believe there may be a puff or two left in RadioShack. Much of the investment world sees the company as a “value trap,” and it is priced accordingly.
As a postscript, back in 2003, Circuit City was also trading below NCAV. During the subsequent four years, shares rose nearly 300%. Owning Circuit City in those days was not a bet that the company would survive and ultimately thrive longer term. Rather, it was a bet that shares were cheap at a given point in time.
We’ll see if history repeats itself with RadioShack. It’s certainly not for the faint of heart; only those with an iron stomach need apply.
The Street
