Monday, June 12, 2006

A Tale of Two Retailers

News Analysis
June 12, 2006

Business Week Online

A Tale of Two Retailers

Drugstore chain Rite Aid recently hit a 52-week high, while RadioShack smacked a 52-week low. Neither stock looks like an impulse buy

One sells drugs, the other plugs. You may be able to cruise by Rite Aid (RAD ) and RadioShack (RSH ) on the same trip -- maybe even in the same strip mall -- but the two retailers' stocks have been moving in opposite directions. Rite Aid shares climbed recently as demographic trends have pointed in the drugstore chain's favor. Meanwhile, investors have so far left electronics merchant RadioShack's nascent turnaround effort on the shelf.

On June 5, Rite Aid's share price touched a 52-week high of $4.90, up 51.7% from a low of $3.23 set on Nov. 14, 2005. The stock's rise followed surprisingly strong earnings reports the previous session from larger rivals CVS (CVS ) and Walgreen's (WAG ). Shares in Camp Hill (Pa.)-based Rite Aid sold for $4.59 in afternoon trading on June 9.

RadioShack shares scraped their 52-week low of $14.17 on June 8, amid a severe intraday equity market selloff on worries about rising global interest rates (see, 6/9/06, "A Global Assault on Inflation"). A day earlier, Stifel Nicolaus analyst David Schick downgraded the stock from hold to sell. Shares in the Fort Worth-based retailer were at $15.16 in afternoon trading on June 9, down 44.3% from a high of $27.24 reached on Aug. 11, 2005.

PHARMACY GAME.  Is it time for these stocks to reverse course, or will they each remain on their respective tracks? Well, sometimes a product's sticker price is just right. Although Rite Aid's shares have risen and RadioShack's have tumbled, analysts suggest that neither stock is poised for a significant move anytime soon, for better or for worse.

Rite Aid runs about 3,300 drugstores in 28 states and Washington, D.C. On Apr. 6 the company posted fiscal fourth-quarter profits that fell below some analyst estimates, boosted by a 9.9% increase in sales. Despite positive long-term trends, Rite Aid faces a number of challenges as it jostles for space in an increasingly competitive industry, analysts say. A company spokesperson declined to comment on the share price.

The drugstore business overall stands to gain over the long term from aging baby boomers, who will presumably buy more medications, analysts observe. Pharmacy sales were a bright spot in the company's fourth-quarter results, increasing 2.5% amid gains related to Medicare Part D, the new drug benefit plan. Rite Aid's fundamental outlook remains difficult, but upside is large if a solid (although not heroic) turnaround occurs, wrote Credit Suisse analyst Edward Kelly in a May 4 report rating the stock outperform. (Credit Suisse acts as a market maker in Rite Aid and RadioShack securities.)

EXPANSION BENEFITS.  Still, Rite Aid's dependence on filling prescriptions could also be a liability. The company's relatively low profit margins mean that changes in Medicaid, Medicare, or generic drugs will have a greater impact on Rite Aid than on its rivals, according to HSBC Global Research analyst Mark Hutton in an Apr. 28 report. Hutton has an underweight rating on the stock.

At the same time, Rite Aid's front-of-the-store sales (i.e., nonpharmacy) lag behind those of its competitors, but analysts say that's not a critical variable. Given the company's well-developed merchandising skills, this laggard performance remains a bit of a mystery, writes Goldman Sachs analyst John Heinbockel in a May 4 report. Nevertheless, Heinbockel rates the stock a buy. (Goldman owns 1% or more of Rite Aid common equity, expects or intends to seek compensation for investment banking services from Rite Aid, and had an investment banking relationship with Rite Aid in the past 12 months.)

Rite Aid's share price hit its peak as the drugstore industry is enjoying an expansion phase. Some say Rite Aid's additions have been right on the money. Their growth has been pretty savvy, says George Whalin, president and CEO of San Marcos (Calif.)-based Retail Management Consultants.

SHACK SHAKEUP.  However, Rite Aid's low cash flow relative to its peers may impose another hurdle as the company tries to keep getting bigger. With major competitors also focusing on expanding their asset bases, and competition increasing from other formats, we remain concerned that [Rite Aid's] high debt levels may limit its longer-term growth prospects, wrote Standard & Poor's analyst Joseph Agnese in January. He has a hold recommendation on the stock. Still, Rite Aid has slashed its debt to about $3 billion from $6 billion in 1999, when the company brought in new management.

Meanwhile, RadioShack faces challenges of its own. The company runs about 6,600 stores under company-owned and dealer-franchised formats, making it the largest electronics retailer by number of locations, but it lags behind Best Buy (BBY ) and Circuit City (CC ) in sales. We clearly have a lot more work to do to get this company back to levels of profitability and growth that we all expect, said Claire Bobrowski, president and acting CEO of RadioShack, in an Apr. 21 conference call. (A company spokesperson declined to comment on financial performance before second-quarter earnings are announced on July 21.)

A management shakeup is only one of the question marks hanging over the company. On Feb. 20 then-CEO Dave Edmondson stepped down following a report that he did not have the bachelor's degree listed on his résumé (see, 2/22/06, "RadioShack's Lesson: Trust, But Verify"). A search for a permanent CEO is ongoing.

The recent turmoil in company leadership&ellip;has, as we expect, introduced an element of turmoil throughout the organization, wrote Raymond James analyst Budd Bugatch in an Apr. 24 report reaffirming a market perform rating. (Raymond James expects to receive or intends to seek compensation for investment banking services from RadioShack.)

SERIES OF LETDOWNS.  RadioShack's cell-phone business also continues to ring up disappointment following last year's switch of carrier affiliation from Verizon (VZ ) to Cingular. The transition remains challenging, Deutsche Bank analyst Mike Baker noted in a May 15 dispatch, with the main issue being a slow ramp in Cingular trends in areas where the company does not have a large market share.

Baker likes the company's decision to reduce capital expenditures on new wireless kiosks but says the lack of share buybacks forecast in 2006 is a bad signal. He rates the stock a hold. (Deutsche Bank makes a market in RadioShack securities, owns 1% or more of the company's common equity securities, and expects to receive or intends to seek compensation for investment banking services from RadioShack.)

Unlike Rite Aid, RadioShack has many locations in enclosed malls. These roughly 1,200 stores could represent one of the bigger issues long-term, writes Credit Suisse analyst Gary Balter, who has a neutral rating on the stock. Mall traffic -- which skews toward teenagers, mothers, and senior citizens -- isn't necessarily ideal for RadioShack's product mix, analysts say.

Then there's customer service. Higher staffing levels contributed to higher first-quarter spending, but the effort was less successful in driving sales than executives had hoped. Meanwhile, rival Best Buy has scored a marketing success with its Geek Squad, a 24-hour customer-service group.

BOTTOMING OUT.  RadioShack's customer-service push may face an uphill battle, according to some analysts. That's fine to talk about, but to actually implement it, and implement it from mall-based locations? says Michael Tesler, president of Norwell (Mass.) retail consulting firm I wish them luck.

While the electronics retailer's stock might look like a deep-value opportunity at current lows, some analysts caution against buying too soon. Although the stock has already shed half its value in 18 months, share prices may not be ready to rise, analysts say. We believe results could be so far below current consensus that EPS estimate revisions could be tough on share performance in the near term, Stifel Nicolaus' Schick wrote on June 7. (Stifel Nicolaus expects to receive or intends to seek compensation for investment banking services from RadioShack.)

Consumers seeking blood-pressure pills or RCA cables may need to pay Rite Aid or RadioShack a visit. But investors might not want to put the retailers' stocks on their shopping lists just yet.

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