Goldman Sachs Buys Huge Stake in RadioShack

Through SEC documents filed Monday we learned that Goldman Sachs Asset Management has bought a 12.6% stake in electronics retailer RadioShack (RSH). Normally this would not be very newsworthy, as the largest asset management firms usually have big stakes in companies that require reporting. Fidelity is the largest mutual fund manager and is on top ten institutional holders lists all the time. What is interesting about this Goldman disclosure is that they bought a lot of RSH and did so very quickly.

As of March 31, 2007, with RadioShack trading at $27 per share after being the best performer in the S&P 500 during the first quarter, Goldman owned just 1,755,884 shares (about 1% of the company). In a little more than two months they have increased their holdings by a factor of ten to become the second largest holder (behind Fidelity’s 15%) and that news helped send the stock up nearly 2 percent on Monday.

Should investors go out and buy RSH on this news? Not at all. Such heavy buying explains why the stock has remained strong in recent weeks. Given that Goldman filed with the SEC, we can assume they are done buying large blocks of stock. Investors in RSH who own it for the potential for further earnings per share gains (above current estimates) are justified, but a purchase just for the sake of following Goldman is a bit too late.

Recently I trimmed some RSH positions in accounts where it got to be a top holding. I still expect the stock to move toward $40 per share, but the bulk of the gains for 2007 are likely behind us, unless something unforeseen happens. Interestingly, I have been looking closely at the other electronics retailers recently and RSH is not the only one that looks attractive from an investment standpoint. Perhaps I’ll go into more detail in a future post.

Full Disclosure: Long shares of RSH, as well as January 2009 $10 LEAPS

Despite Harsh Words from Critics, Share Buybacks Remain a Great Way to Boost Earnings and Share Prices

You might know Herb Greenberg, an often quoted columnist for MarketWatch and a frequent guest on CNBC, as someone who focuses on telling the bearish story on the market. Although I’m about to refute one of Herb’s recent blog posts entitled “AutoZone: Sustainable Model?” regarding auto parts retailer AutoZone (AZO), I will admit that there are not enough people out there telling people what could go wrong. Wall Street is too often about selling stocks to people, and with that comes a bias toward making the bullish case for an investment, not the bearish one. Although betting against stocks stacks the odds against you, Herb makes it his duty to tell the other side of the story.

In the case of AutoZone, here is what Herb had to say about the company on May 22nd:

“Earnings per share beat estimates, yet again, thanks to buybacks. Who cares about sales missing estimates? Who cares about sales per square foot that are either down or flat year-over-year for 12 consecutive quarters? Or inventory turns at a multi-year lows? Or sliding sales per store? Or continued weak same-store sales? All that matters, in a buyback story, is earnings per share. “The point,” says one longtime skeptic, “is whether that’s a sustainable business model. Anybody can do this for some finite period of time, but only the ‘productivity loop’ (as exemplified by Wal-Mart in its heyday and others) has proved sustainable.”

Herb does have his facts right, AutoZone has not been greatly improving their sales or inventory turns for a long time. However, when trying to judge the merit of a bearish argument, you have to ask, does any of this stuff matter? From reading Herb’s post, it is obvious that he, as well as the long-time skeptic he quotes for the piece, believe that it does matter in terms of the future for AutoZone stock.

Noticeably absent from the piece, however, are any reasons why sales, sales per square foot, inventory turns, sales per store, and same store sales do matter, or why share buybacks are bad. He simply states that a business model that focuses on buybacks, and not sales or inventory, is not sustainable. There is nothing there that explains why it isn’t sustainable. Why may that be?

If you do some digging into AutoZone’s financials over the last fifteen years, you will see that the model is sustainable. The company has been focusing on stock buybacks since 1999. This year will mark the ninth straight year that choosing buybacks over sales growth has worked for them. The argument that the model isn’t sustainable simply does not hold water because the evidence, which I will detail below, points to the contrary.

Now, why has the model worked? Why has it proved wise for AutoZone to reinvest excess cash into its own shares rather than new stores, or other projects focused on traditional retail metrics? Because buying back stock will boost AZO’s earnings more than opening a new store, or implementing new inventory management software will. And when it comes to getting your share price higher, earnings are what matters, not sales, or comp store sales, or sales per square foot, or inventory turns.

Herb writes “All that matters, in a buyback story, is earnings per share.” That is only partially correct. All that matters, in the stock market, is earnings per share. Stock prices follow earnings over the long term because owning a share of stock entitles you to a piece of the company’s earnings. Not sales, but earnings.

Let’s take a look at AutoZone in more detail. The company’s history since its IPO in 1991 tells two distinctly different stories. From 1991 through 1998, AutoZone focused on traditional retail metrics, the ones Herb and his skeptic friend believe are important when evaluating a stock’s investment merit. During that time, sales compounded at a growth rate of 22 percent per year, with same store sales averaging 8 percent growth. Stock buybacks were not used, resulting in total shares outstanding rising each and every year due to option grants.

However, in 1999 AutoZone began to focus on stock buybacks, an effort that was very much an idea from a relatively unknown hedge fund manager by the name of Eddie Lampert, who had begun to amass an investment position in AutoZone stock. Lampert understood the retail sector well, and knew that industry experts loved to focus on same store sales and other metrics like that. But he also knew that such metrics had very little correlation to stock market performance, and as an investor, that is all he really cared about.

As a result of pressure from Eddie and other investors, Autozone began to implement a consistently strong buyback program. Total shares outstanding peaked in 1998, fell year-over-year in 1999, and have fallen every year since. Not surprisingly, with a new focus on share buybacks, there was less cash flow left over to improve store performance in ways that would be reflected in same store sales, sales per share foot, and inventory turn statistics. Not surprisingly, since 1999 sales have only averaged 8 percent growth per year, with same store sales compounding at a 3 percent rate. Both of those are far below the levels achieved before the buyback era began at AutoZone.

So the punch line of course lies in what happened to AutoZone stock during these two distinctly different periods. Herb Greenberg and other long-time skeptics would have you believe, without evidence to support their claims, that sales and inventory matter to Wall Street. I am writing this to prove to you that such arguments are wrong.

AutoZone’s stock ended 1991 (the year of its IPO) at $10 per share and reached $26 by the end of 1998, for an increase of about 150 percent. The buyback program reduced share count for the first time in 1999 and today the shares fetch $127 per share, an increase of about 390 percent from 1998. How could this be the case if sales growth and other metrics of retailing health were so much stronger in the earlier period?

The answer lies in the effects of the buyback program. Share count peaked in 1998 at 154 million and now sits below 70 million. So, if you bought 10% of AutoZone at the end of 1998 and held those shares until today, you would now own 22% of the company, without buying a single additional share. And although AutoZone’s sales growth has slowed in recent years, the company is still larger now than it was then, so shareholders not only have seen their ownership stake more than double, but the entire company is worth more today than it was in 1998.

Hopefully this explains why retail metrics like sales don’t really matter when it comes to share price appreciation. Earnings are all that counts, not just in a buyback story, but in any story involving the stock market. I believe Herb when he characterizes his source as a “long-time skeptic” of AutoZone. He likely has been bearish on the company ever since they decided to put buybacks ahead of sales on their priority list eight years ago. However, the skeptics have been wrong for many years and the reason is pretty simple; the buyback model has proven to be quite sustainable.

Full Disclosure: No position in AutoZone at the time of writing

AutoZone vs S&P 500 Since Market Peak in March 2000

I’m Not Holding My Breath for a Dell-RadioShack Deal

I get a kick out of some of the ridiculous deals that are rumored on the Street. Did anyone really think Sears Holdings (SHLD) would buy Anheuser Busch (BUD)? The latest story comes to us from Business Week, speculating that Dell (DELL) could buy RadioShack (RSH) in an attempt to reinvigorate its business after Hewlett Packard (HPQ) has kicked their butt for a while now.

How does this rumor get published? There is no evidence whatsoever that Dell would even consider buying an electronics retailer. Did RadioShack shares really jump 6% Monday on this story? It’s insane. Remember the Gateway Country store concept? Huge bust. That was nearly as bad as waltzing into large corporations trying to sell computers in cow boxes.

The current market environment is very conducive to spreading M&A rumors. After all, the sheer volume of deals right now is astounding. That said, don’t put stock into the stories that don’t really make any sense. If you are looking to sell some stock, use these temporary bumps to sell into the rumors if you don’t think they have merit. A client of mine did that with BUD when merger rumors surfaced, and it proved to be the top in the stock.

I didn’t sell any RSH Monday into the rally, but that is because I like the stock for other reasons, not based on a silly buyout rumor. If anyone was going to buy RSH, you’d think it would be Sears, not Dell.

Full Disclosure: Long shares of RadioShack and Sears Holdings at time of writing

RadioShack Earnings Prove Naysayers Wrong Again

Despite bearish stories out of Barron’s and the Wall Street Journal in recent weeks, electronics retailer RadioShack (RSH) shook up those betting against the stock this morning by reporting first quarter earnings that more than doubled analyst estimates. Shares are up nearly 10% this morning.

If this sounds familiar, it is exactly what has propelled shares of Sears Holdings (SHLD) from $15 to more than $190 each. Analysts, reporters, and industry experts will always sound the warning bells when they see overall sales declines, especially same store sales. Although many believe SSS to be the best indicator of a retailer’s health, stock prices reflect earnings, not sales.

We are likely to continue to see naysayers complain about poor sales at RadioShack. After all, they did the same thing with Sears and even continue to do so, despite the stock’s astronomical move. I would expect analysts to continue to underestimate the earnings power of RSH, just as they have done with SHLD. As a result, neither stock is ripe for sale yet despite the fact that negative press will continue to cause temporary worries and sell-offs along the way.

As I have written about before, RadioShack is imitating the Sears Holdings model of ridding itself of unprofitable sales. Over the last three months, RSH has shrunk its business from 6835 retail locations to only 5205. The result of closing underperforming stores has been declining sales, as one would expect, but gross margins jumped to 52% from 48% last year and earnings soared to $0.29 per share, more than doubling the consensus forecast of $0.14 per share.

Full Disclosure: Long shares of RadioShack and Sears Holdings at the time of writing

The Saks Turnaround is Worth Watching

Followers of Peridot Capital are well aware that I am a big fan of turnaround stories in the retail industry. Historically poorly run retailers can be revitalized if the right management team is brought in to oversee the turnaround. Not every instance will result in the 1,200 percent return Kmart shareholders have earned since the company came out of bankruptcy and merged with Sears (SHLD). However, RadioShack (RSH) was the best performing stock in the S&P 500 during the first quarter, and other retailers like Eddie Bauer (EBHI) and Pier One (PIR) have been run into the ground in recent years, so there is a lot of upside potential if the right people are hired to run the business.

One other retail stock I think warrants value investors’ attention is Saks (SKS). The company unloaded its lower end department store brands last year to focus more on its upscale luxury offerings. A new management team is trying to boost merchandising in order to get margins up to the level of competitors such as Neiman Marcus and Nordstrom (JWN).

The early results have been positive. Investors were slightly disappointed with the company’s March same store sales growth of 10% (expectations were for a few percentage points more), but after a dismal performance in recent memory, comps at Saks are accelerating. When you focus on the high end of the market, as Saks does, you have far more pricing power, so margin expansion is highly likely if management continues to do a good job merchandising.

After trading down to $19 after releasing March sales this morning, SKS shares have rebounded to more than $20 each. I think they are interesting in the teens. Despite a rally lately as the turnaround has taken shape, the stock still trades at less than one times sales. The P/E looks high due to depressed margins, but the leverage there could result in exploding earnings in coming years. If you look at what type of price Neiman Marcus was able to garner when it went private, you can see that Saks is a prime comparison and trades at a very attractive level. Shares could easily fetch a price in the mid to high 20’s if the turnaround continues to be successful.

Full Disclosure: Author was long shares of Eddie Bauer, RadioShack, and Sears Holdings at time of writing

Sears Holdings Securitizes Its Brand Names

According to a story in Business Week magazine, there is more evidence that Eddie Lampert’s Sears Holdings (SHLD) is a lot more than just a company that has supposedly lost its relevance in consumer retailing. A move to securitize the Kenmore, Craftsman, and Diehard brands for $1.8 billion shows just how creative Lampert and Co. are at creating value for shareholders, or in this case, the potential for future value creation. Read about how they could monetize the Sears Holdings brands.

Full Disclosure: Long shares of Sears Holdings at the time of writing

Moodys Does What to their RadioShack Credit Rating?

NEW YORK (AP) — Moody’s Investor Services downgraded RadioShack Corp.’s long-term senior unsecured rating and short-term commercial paper Monday on lackluster sales and operations. The ratings agency lowered the electronics retailer’s senior unsecured rating to “Ba1” from “Baa3.” The move means the company’s senior unsecured rating is no longer investment grade. Moody’s also cut RadioShack’s commercial paper rating to “Not Prime” from “Prime-3.”

Sometimes you have to wonder what exactly rating agencies like S&P and Moody’s are looking at when they change corporate bond ratings. This news isn’t material for RadioShack (RSH) common stockholders, but still, it doesn’t make sense.

As I pointed out recently, the RadioShack turnaround is on solid ground. Despite the surge in earnings at the company, Moody’s is looking at sales numbers, not profitability and balance sheet metrics when rating the company’s debt. Not only have most equity analysts missed the huge run in RSH shares, but it appears debt analysts are pretty clueless as well.

RSH has had a huge run, so I wouldn’t be aggressively buying at the current price above $26 per share. That said, a credit downgrade to below investment grade seems to be a strange thing to go ahead with when operations are improving.

Full Disclosure: Long shares of RSH at time of writing

Dow’s 400 Point Drop Aside, RadioShack’s Turnaround is Solidly in Place

Despite Tuesday’s dramatic 416 point drop in the Dow Jones Industrial Average, you may have noticed one stock that managed to gain 12% for the day. That stock was RadioShack (RSH), the electronics retailer that I highlighted earlier this month as a major turnaround candidate in retailing, similar to Sears Holdings (SHLD).

Why all the fuss over RSH shares when the rest of the market was getting pummeled? Well, the company reported fourth quarter earnings of $0.62 per share, soaring past the $0.43 forecasted by analysts. RadioShack also gave 2007 earnings guidance of $1.00 to $1.20 per share. That second part is most important because the average estimate for RSH’s earnings is $1.12 in 2008!

That’s right, analysts aren’t exactly confident about RadioShack’s prospects. In fact, heading into the earnings report, more of them rated RSH a “sell” than a “buy” (quite a rarity on Wall Street). Prior projections of $0.91 in EPS for 2007 and $1.12 in 2008 will obviously have to be adjusted upward dramatically, as the company is on track to beat the current 2008 estimate one year early.

Since the turnaround plan at RSH was not expected to be bearing this much fruit so early, the stock price is adjusting to the success newly crowned CEO Julian Day is having. The stock has gone straight up from $16 to $25 in recent months, so investors might want to hold off buying more until the stock pulls back a bit. However, the company’s turnaround plan is firmly in place, and equity holders will likely reap the benefits over the next several years.

Full Disclosure: Long RSH and SHLD at time of writing

Is RadioShack the Next Kmart?

Ask the average person on the street to compare RadioShack (RSH) to Kmart and you will likely hear a lot of similarities posed from people who have no investment background at all. Both retailers were a lot more popular with shoppers many years ago, but were run poorly and new chains have stolen their customers. It’s not hip to go to either place to buy something. Kmart shoppers now visit Wal-Mart (WMT). RadioShack’s customers likely prefer Best Buy (BBY). So, in that sense RadioShack is Kmart.

But let’s look at this from an investment perspective. Followers of Kmart’s emergence from bankruptcy and subsequent merger with Sears (SHLD) know that good management led to a stock surge from $15 to $175 in a few years’ time. RadioShack isn’t quite in as bad a shape as Kmart was (the company is not close to going under, but profits have tumbled and the stock price has followed suit) but the outlook is bleak and shoppers likely have a long list of stores they’d prefer to go to before RadioShack for most electronic products.

The similarities don’t end there. RadioShack has embarked on a turnaround plan that is being led by CEO Julian Day, who has been running the retailer since July. Kmart/Sears fans may recognize this name. Day ran Kmart upon its exit from bankruptcy, leading the company’s comeback, which ultimately allowed Kmart to buy Sears outright. Now at RadioShack, Day is trying to revive the company (and its stock price) using the same methods that brought Kmart back from the dead.

The similarities, in fact, are striking. RadioShack is closing down unprofitable stores, focusing on profits and not sales (and as a result, comp store sales are declining, much like Sears Holdings), and has even discontinued quarterly conference calls, a favorite move of Eddie Lampert. Though Day has only been at RSH for about six months, early indications are that the plan could very well work. On January 8th, RSH preannounced a positive fourth quarter and the stock jumped more than 10 percent.

Now I’m not saying RadioShack shareholders are in for some sort of parabolic ride, on the order of the 1,000 percent gain in shares of Sears Holdings. Far from it, in fact. However, investors have seen this concept play out before. RadioShack appears to be just another retailer that got in trouble by chasing unprofitable sales, hoping that revenue would solve its problems. However, on Wall Street earnings are what matter and earnings growth has never been boosted by selling product for less than one paid for it.

It will be interesting to see how well newly crowned CEO Julian Day can turn around this seemingly dead company. Many investors don’t seem to be very enthused, as short interest in RadioShack is about 15% of the company’s float. However, with 6,000 stores worldwide and a proven plan in place, there seems to be a lot of potential.

Full Disclosure: Long RSH and SHLD