One Person's Trash Is Another Person's Treasure Selection: Staples

About a month ago, I announced my intention to create a portfolio composed of 10 companies that investors have unjustly cast aside. My goal in creating the One Person's Trash Is Another Person's Treasure portfolio is to highlight just how successful value investing and contrarian viewpoints can be, as well as uncover some great companies that have a good chance of turning their fortunes around. For a more thorough explanation of what I hope to accomplish and how I'll measure my success, I encourage you to visit my portfolio mission statement.

For reference, here are my previous four selections:

For my fifth selection, I've chosen office-supply superstore Staples (NASDAQ: SPLS  ) .

Why traders have given up on Staples
It's not just Staples but the entire office-supplies sector, including OfficeMax (NYSE: OMX  ) and Office Depot (NASDAQ: ODP  ) , that are having a miserable year. The ongoing European debt crisis and a slowdown in China's growth rate have curbed spending internationally, while domestic sales have suffered from reduced capital expenditures for small businesses that have been hurt by tighter consumer spending. Undoubtedly, some of that reduced spending has to do with slowing GDP growth, but I wouldn't be surprised, either, if office-supply chains have seen orders delayed because of the looming fiscal cliff and higher employee health costs associated the implementation of the Affordable Care Act in 2014.

In August, Staples clipped estimates for the full year on these worries, and analysts cautioned that increased competition in domestic markets could further hamper its results. Pricing pressure from online retailers such as Amazon.com (NASDAQ: AMZN  ) , discount drugstores such as Walgreen (NYSE: WAG  ) , and even low-priced grocery chains such as Kroger (NYSE: KR  ) , for items ranging from stationary to electronics are putting margin pressure on a sector with razor-thin margins to begin with. Needless to say, Staples could use an Easy Button of its own this year.

Why investors should trust Staples
It's probably not easy to trust a company that's so reliant on U.S. small businesses for growth considering that consumer spending growth is tepid at best, but there are plenty of reasons to be optimistic about Staples' future.

For one, Staples has been proactive about downsizing its operations to streamline sales of product, reduce expenses, and make its entire business more efficient. In late September, Staples announced that it'll be reducing its U.S. floor space by 15% over the next three years as it turns its focus toward online sales. You might be thinking to yourself, "Yeah, OK, we've heard this from big-box retailer Best Buy (NYSE: BBY  ) , which said it was going to close 50 larger stores in favor of opening 100 smaller mobile-focused locations!" You're right, but what you're forgetting is that Staples is a proactive company, not a reactive one like Best Buy. Staples' online office-supply business ranks second behind only Amazon.com, so that chances of it being undercut in price are growing smaller.

Second, do you really think OfficeMax or Office Depot have any hope of competing against the likes of Staples, online behemoth's like Amazon, or small business assassin Wal-Mart (NYSE: WMT  ) ? OfficeMax received a bit of good news earlier this year, when a bankruptcy court allowed it to wipe clean $871.5 million in debt backed by Lehman Brothers, but outside of this action it's been an ongoing struggle for both OfficeMax and Office Depot, which have been rumored to be merger buddies for as long as I can remember. Also, Staples' trailing 12-month operating margin of 6.2% as compared with OfficeMax or Office Depot's same margin of 1.7% and 1.5% tells me all I need to know about the better buy in this sector.

Finally, Staples does make things easy for income-seeking investors. It's currently yielding nearly 4% and its annual payout has doubled in just the past six years.

What you'd get here
I feel that investors are getting in practically on the ground floor of an office supply superstore that's transitioning from being a large-scale warehouse to a nimble company with smaller, more efficient, stores, and with online operations capable of competing with, and undercutting, many of its peers without sacrificing too much of its operating margin.

Currently, Staples is trading at just eight times forward earnings and, as I alluded to, it pays out a handsome 3.9% yield that's gone up every year since 2006. It offers a higher operating margin than its peers and it gives investors exposure to American small business from both a retail and online standpoint. In addition, even with $640 million in net debt, Staples' four-year streak of $1 billion-plus in free-cash generation lends credence that it's still well-capitalized and able to sustain not only its dividend, but its operational transition efforts.

Check back next week, when I unveil the sixth in a series of 10 selections for the One Person's Trash Is Another Person's Treasure portfolio.

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