Picking Staples off the Floor

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World’s leading office supplies firm, Staples Inc (NASDAQ: SPLS) is moving forward with its cost cutting strategy with the objective to save $250 million annually by shutting dozens of stores out of 1,583 in the US and 331 in Europe. The firm's falling sales in two consecutive quarters have sent its shares tumbling by more than 17% since January due to weak US job numbers and the debt crisis in Europe. The company relies heavily on small business (SME) growth but the sluggish economic environment following the global financial crisis gutted small business in the U.S, though the trend in SME bankruptcies is down.  The company is planning to use the savings to boost its Internet retail operations as the growth in the smart-phone and PC industries is translating into higher Internet and mobile orders.

In this challenging environment, Staples will embark upon several different strategies.

  • Improve its revenues from non-core operations such as break-room supplies, mobile phones, tablets, accessories and electronic readers.
  • Downsizing and store relocation to improve its productivity. Total square footage in the US is going to drop by as much as 15% by 2015 while it tries to improve the efficiency of its online and mobile operations.
  • 30 stores will be closed in US will another 30 will be downsized in 2012.
  • The European printing system business will be sold while the Australian operations will go through a re-branding.

Fortune reported in September that some private-equity firms were considering acquiring Staples, although no buyout is expected this year. US presidential candidate Mitt Romney’s Bain Capital was an investor in Staples and any business interested in the purchase, including Bain Capital, will wait until the election season is over. Since this revelation the company’s shares have climbed by 5.5%.

In its recent quarterly filings for the period ending 28July, Staples revenues dropped 10% sequentially and 5.5% annually to $5.5 billion while profits slumped 35% sequentially and 31% annually to $120 million. Overall, the business has recorded fourth consecutive decline in quarterly revenues and profits.

In mid-August, Staples had reduced its year end guidance with revenues to remain flat as compared to last year’s $25.02 billion while EPS would increase to a low single-digit. Analysts were already expecting it to post $25.25 billion in revenues and EPS of $1.47. The firm has planned to return $1 billion to shareholders through dividends and share buybacks by the end of the current fiscal year ending 28 January, 2013.

I'm not a fan of share buybacks during a restructuring, but because Staples is so widely held by institutions (92%) management is worried about forced liquidations if the share price drops below $10 per share, even if it's not in the company's long-term best interest. 

Staples is still a market leader when it comes to office supplies and the world’s second largest internet retailer therefore it is an attractive acquisition target. But it has a high enterprise value of $8.9 billion and its future outlook is closely tied with job creation. Although consumer confidence and the housing sector has started showing signs of a recovery, the job outlook remains weak.  Even with Unemployment rising in nominal terms, wages in the U.S. are falling.  According to data compiled by Bloomberg, sales of firms in S&P 500 have fallen a second time in a row, by 0.9% in Q3 YoY. Although, it is expected to increase by 1.2% in Q4 but that is just holiday season noise.

This implies that all businesses, including Staples, will continue with their own austerity measures. There is not going to be any significant increase in the number of small businesses and demand for office machines will remain weak therefore the outlook for Staples and its rivals such as Office Depot (NYSE: ODP) and OfficeMax Inc (NYSE: OMX), will remain weak.

Like Staples, OfficeMax is also expecting its year end revenues and operating income to remain essentially flat as compared to 2011. On the other hand, Office Depot is aiming to beat the analysts' EBIT estimate of $93 million for the current fiscal year with EBIT between $125 million and $135 million. Both Office Depot and Office Max have recently reiterated their full year and quarterly guidance. Unlike Staples, Office Depot and OfficeMax have increased by 19% and 72% YTD. The rise of both the companies has mainly come in the second half of 2012. Both of them have outperformed SPDR S&P 500 ETF (NYSEMKT: SPY) which is up 14.7% YTD. Starboard Value LP has recently become the dominant shareholder of Office Depot which caused the share hike while OfficeMax has been able to more than double its net income from $5.4 million in March to $11.2 million in June.

Fitch has recently affirmed ‘BBB’ rating to Staples with a stable outlook. Investors have been particularly pleased with the restructuring efforts and cost cutting measures, which seems a rational option in the current environment. Staples has strong cash flows and its cash reserves of $984 million is far more than the market cap of Office depot ($730 million) and OfficeMax ($676 million). Revenues and income are going to remain flat but it will continue to generate cash for its investors. At a P/E of ~9 with a 3.7% yield Staples is looking like a value-trap while it defends its price and rids itself of unneeded assets.  Since I’m not bullish on the U.S. economy in the medium term, it is hard to justify Staples as anything other than a substitute for a low-yield bond.

PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Staples. Motley Fool newsletter services recommend Staples. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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