Staples May Survive After All  

Is Staples in the midst of a miraculous turnaround?

At one time, Staples Inc. (NASDAQ: SPLS) was a fast-growing office-supplies superstore, crushing all the mom-and-pop stationary stores that were dotted all over America. The company went public at a split-adjusted price of about one dollar and peaked in 2006 at about $28 per share.
But, as often happens to growth companies, the easy growth had stagnated. Competition was growing thanks to OfficeMax and OfficeDepot (NYSE: ODP). That was on top of legacy companies like U-Line, now owned by Middleby Corp (NASDAQ: MIDD), an idea offered at last year’s Baron Conference.
Eventually, other companies got into the office supply game, like Target (NYSE: TGT) and (NASDAQ: AMZN). As a result, Staples shares plummeted from a high near $26 in February 2010 to a low of less than $11 in July 2012.
The truth is that office supplies are commodities. Scale means everything when you sell commodities, because margins are so thin, so the expense part of the Profit & Loss statement means everything.
The financial crisis didn’t help anyone, either.
Now, OfficeMax is owned by OfficeDepot. That leaves fewer superstore chains, but competition remains fierce. As all the chains struggled, Staples changed its mentality. It got into turnaround mode just about two years ago. So far, things are working out.
Staples began pushing customers to its online operation to more effectively compete with Amazon and U-Line, and to reduce overhead. The company is now at the point where about half its sales are online through its own website and those of others.
It is closing underperforming stores (225 alone in 2015, on top of 170 in 2014), and that’s probably a good idea because the retail superstores just aren’t what they used to be. The business model of an actual brick-and-mortar store base is no longer as viable because of the high costs. Even the economy of scale its massive presence has just isn’t enough to meaningfully make a difference in the competitive environment.
Fortunately, Staples has moved aggressively into the commercial side of things, and that’s been performing well even as retail same-store comps decline.
Still, it’s going to be a while before we see these efforts show up in the numbers. In the most recent quarterly report, earnings per share fell 12% year-over-year on a 2.5% decline in revenues. Management said this quarter’s earnings would be 3-5% below last year’s.
Financially, however, the company is doing fine. It has $770 million in cash and only $1.02 billion in debt. It still generated $800 million in free cash flow over the trailing 12 months. That’s a fairly robust financial foundation it rests upon.
There’s some speculation that Staples could merge with OfficeDepot, which has $985 million in cash and $1.5 billion in debt, but is break-even on a free cash flow basis. That would certainly result in big cost savings.
For investors, the question is whether the turnaround ultimately pans out. The market has bid up the stock to $17.66, up 70% from its 52-week low. That would seem to price in a lot of optimism. When the company reports in March, total fiscal-year earnings should come in around $0.95 per share, meaning the stock trades at more than 18x estimates.
That’s the kind of valuation you see for a growth stock, not for a turnaround that’s still in progress. For now, I think all the optimism is priced in. If you want to buy into the turnaround, I’d wait for the stock to fall at least below $14.

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