RSH is a net-net trading at 0.61x P/NCAV and 0.34x P/NTA. 0.34x P/NTA is a new historical low for RSH; its previous historical low was 1.2x P/NTA during the global financial crisis in 2009. The cash on the books of RSH at $546.1 million is more than double its current market capitalization of $210.1 million. However, RSH is not in a net cash position.
Financial and Business Risks
RSH is highly geared with a gross debt-to-equity ratio of 113% and a net gearing of 31%. This does not take into account off-balance sheet liabilities such as operating leases and purchase obligations.
There are two types of leases: finance leases which appear on the balance sheet as financial liabilities, and operating leases which only show up in the income statement as rental expenses. This does not reflect economic reality. The most common form of operating leases is the rental of storefront by retailers. Retailers either borrow money to own the store front and repay the debt over the period of the loan, or pay fixed commitments in the form of rent over the period of operation. In reality, operating leases are no different from loans. Operating lease expenses should be capitalized to approximate the value of debt on the books.
RSH had operating lease obligations of $577.5 million as at Dec. 31, 2011, and purchase obligations of $509.9 million as at Sept. 30, 2012. Purchase obligations include product commitments and marketing agreements. The increase in purchase obligations from $333.2 million as at Dec. 31, 2011 is the result of inventory build-up and advertising commitments related to the fourth quarter holiday shopping season. Off-balance sheet liabilities add significantly to RSH's existing debt of $749.2 million on the books.
Business Quality and Capital Allocation
Gross margin for the trailing 12 months fell to 36.7% from a five-year average gross margin of 45.0%. Management attributed the fall in gross profit margin to a change in sales mix towards lower margin smartphones such as the iPhone. However, RSH's problem extends far beyond product mix and this is reflected in three consecutive quarters of losses.
RSH also announced that it had suspended its share repurchase program and dividend policy on Jan. 31, 2012, and July 25, 2012, respectively.
The calculation of net current asset value for RSH does not take into account the operating lease obligations of $577.5 million and purchase obligations of $509.9 million. If we deduct the discounted off-balance sheet liabilities from the net current asset value of $345.5 million, the net current asset value for RSH would in fact be negative.
The valuation case for RSH is weakened by the fact that it is not a real net-net and has a negative net current asset value. The prediction of turnarounds belongs in the realm of market gurus and stargazers. I will stay away from this stock.
The author does not have a position in any of the stocks mentioned.