Second Look: Does Staples Needs A Turnaround Team? (SPLS, ODP, OMX)

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After Wednesday’s disaster of a share performance in Staples Inc. (NASDAQ: SPLS), we are evaluating this situation to see if it is time to bring in a turnaround team?  If you just looked at the post-earnings stock drop of 8.4% to $14.66 many investors would say that the 52-week trading range of $11.94 to $21.50 indicates serious trouble with the DJIA challenging 13,000 (and NASDAQ challenging 3,000) that something is very wrong here.  This is one of those situations that there is no easy solution. 

Office Depot, Inc. (NYSE: ODP) shares fell 8% drop today (with low and spotty earnings as well); Officemax Incorporated (NYSE: OMX) fell 4% and it now trades at 9.2-times expected 2012 earnings.  Staples is worth $10.25 billion after today’s drop, while Office Depot is worth $925 million and OfficeMax is worth only $482 million in market capitalization.
  
The office supplies giant reported that its net income rose to $283.6 million or $0.41 per share. This compared to almost $275 million or $0.38 per share a year earlier and it was in-line with the $0.40 estimate from Thomson Reuters.  Sales were up 0.7% to $6.46 billion from year ago and estimates were roughly $6.45 billion.  Staples is facing a scenario where growth is coming in, but at slower rates than what Wall Street wants. 

The company has slowed down its growth rate massively as it opened 12 stores and closed four stores in the U.S. and opened two stores and closed one store in Canada all in the fourth quarter.  Fourth quarter 2011 comparable store sales increased two percent versus the fourth quarter of 2010, reflecting higher average order size and a slight increase in customer traffic.

Adjusted diluted earnings rose 8% to $1.37 per share and total company sales increased by 2% to $25.0 billion and free cash flow of $1.2 billion for the full year 2011.  Does that sound like a turnaround team is needed?  Sure, Staples’ growth is slowing as the company is mature.

Staples used its cash flow to repurchase 37 million shares for $605 million throughout 2011 and it spent $278 million on cash dividends in 2011.  Translation: Staples is spending twice the amount of cash buying back stock than it is on dividends.  The office supplies destination also ended 2011 with $2.5 billion in liquidity, including $1.3 billion in cash and cash equivalents.

The problem is outside of the U.S. as Staples noted a drop of 5% in U.S. dollars on international sales and a drop of 4% on a local currency basis.  Europe has many problems and a turnaround team cannot really mitigate what is happening in Europe.  The company noted, “Top line growth in European Contract was more than offset by a nine percent decrease in comparable store sales in Europe and weak sales in Australia.”

So, what lies ahead for 2012?  The company’s 2012 outlook is for sales to rise in the low single-digits over 2011 and full year diluted earnings gains of high single-digits per share over the $1.37 EPS in 2011.  Staples also sees an effective tax rate of 32.5% and expects to generate more than $1 billion of free cash flow in 2012.

Staples is a low growth story, but we would ask literally how much growth it can achieve in “the new normal.”  Turnaround teams are needed when you have a booming economy and a company isn’t cutting it.  Businesses keep getting by with less and less.  Fewer employees, fewer office supplies, and fewer office perks. 

The turnaround that investors want is going to likely have to come from a different shareholder base. After today’s drop, Staples trades at 10.7-times trailing earnings and that implies roughly 10-times this coming year’s earnings.

Go look at the size and comparisons for rivals Office Depot, Inc. (NYSE: ODP) and Officemax Incorporated (NYSE: OMX) it really looks like this is not a management turnaround situation.  Staples is a mature situation.  It offers a 2.6% dividend yield, and that is well above average in the retail space.  Maybe the company should allocate a bit more cash and cash flow to dividends rather than share buybacks at its current ratio of 2:1. 

Investors will just have to be patient here, even if the stock could slide a bit more.  Is ten-times earnings expectations with better metrics than peers and a higher dividend all an unfair price?  It doesn’t seem unreasonable. 

Today’s drop was on more than five-times normal volume at 43 million shares.  We do have to note that the death-cross of the 200-day moving average falling under the 50-day moving average just recently came about in the last few days (see stockcharts.com chart below).

JON C. OGG

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