Like others, I got a chuckle out of Radio Shack Corp.’s (RSH.N) Super Bowl commercial. There’s something endearing about a struggling company that can still poke fun at itself. Unfortunately, during the relatively short time since it aired, “the ‘80s called and they want their store back” is no longer a laughing matter. We revisit Radio Shack after its most recent quarterly results to see how it has fared since our earlier story here.
Since that time, the stock has lost over half its value and lenders have blocked management’s plan to close 1,100 underperforming stores (it will instead initially close only 200,and up to 600 over the next three years). After reporting a $98.3 million loss in Q1 fiscal 2015, reported on June 10, an analyst put a $0 price target on its shares. Our predictive models would have helped investors avoid losses as the stock fell to its current $1.08 from $2.25 from early March – a 52% decline.
On June 16, S&P lowered its credit rating on Radio Shack to CCC from CCC+; Outlook Negative. This follows a May 15 Fitch downgrade to CC from CCC, as reported by Reuters. As of June 9, the company had total debt of $649.5 million against the last reported shareholders’ equity of just $73 million.
As the page view screenshot below shows, the StarMine Combined Credit Risk model puts RSH’s default probability at 10.4% over the coming 12 months. Although at first glance this number may seem low, especially when seen in absolute terms, on a relative basis it is worrying: of all companies in North America with a market cap of at least $100 million, only 10 have a higher calculated Probability of Default.
Translating its default probability into the terms rating agencies use, RadioShack’s Implied Rating translates to CC. This puts RSH only a few small notches away from default level. It scores in the bottom decile on measures of profitability, coverage, growth and stability, and liquidity. None of this should come as a surprise to any investor who has examined Radio Shack’s financial statements: the company is battling negative and falling margins, and mounting debt levels. There’s a reason there’s a sea of red in the model components table below.
Source: Eikon/StarMine
Unique model
Our scores are driven by well-established quantitative approaches such as a Merton structural model and creditworthiness ratios. To those, we add a unique model based on text mining unstructured language found in conference call transcripts, news reports, financial filings and permissioned research reports. Importantly, these transparent models offer unbiased scores.
We mentioned that the rating agencies very recently lowered their credit scores on Radio Shack. Our Combined model beat them to the punch. The history chart below shows that its implied rating dropped to CC from CCC- on April 18, 2014. This is not unusual – our research found that when our implied rating differs significantly from the agencies’ ratings, and they subsequently change their rating, they move in the direction of the StarMine calculated level four to five times more often than in the opposite direction.
Source: Eikon/StarMine
Institutions are wary
The sea of red ink doesn’t end with just the credit models but also extends to the StarMine Alpha stock ranking factors. The company’s negative cash flows, profitability and other financial measures also adversely impact Smart Holdings as those are distinctively not characteristics that institutional investors are seeking to add to their portfolios. Those features also don’t make the stock appear inexpensive, even at just over a dollar per share. And, short sellers are betting against the company – more than 30% of all shares outstanding are now sold short.
Source: Eikon/StarMine
Optimism despite challenges
Despite the company’s worsening financial situation, it received an unqualified opinion from its auditors dated Mar. 4, 2014. Surprising or not, management has its work cut out for it.
The company disclosed in the most recent 10-Q that it has tapped $35 million of its new credit facility and expects to “further utilize it during the remainder of the year.” That new facility gave the company a couple hundred million dollars of additional liquidity. The downside is that lenders’ constraints against store closings may make restructuring a bigger challenge.
However, from public statements, management seems pleased with its new concept stores and has begun to remodel 100 outlets. They also seem optimistic about the pipeline of new products and partnerships. We wish them well; but for investors, it’s always worth considering risk alongside potential reward when conducting investment research.
The StarMine credit risk models, in a backtest environment, show promise in their ability to more accurately assess financial distress than other commonly used measures of predicting both credit default and bankruptcy risk and therefore may be a useful addition to the research tools both equity and fixed income investors deploy. Investors, the 21st century is calling.
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