-Did you know that Staples (NASDAQ: SPLS) is the second largest e-commerce seller in the world behind the venerable Amazon.com (NASDAQ: AMZN)? The company's North American Delivery segment reported more than $10 billion in sales during the last four quarters and the company as a whole will generate more than $1 billion in free cash flow during fiscal 2012.
On April 24, Amazon.com announced the launch of Amazon Supply, a separate platform from the company's traditional website to better service the business customer. Shares of Staples have sold off nearly 30% since April 24 as the market is concerned about Amazon becoming a formidable competitor to Staples commercial delivery business. Let's consider some recent data points and consumer research before deciding whether the sell-off in Staples is justified.
- Despite the launch of Amazon Supply, sales within Staples North American Delivery segment have been consistent with prior year performance. Sales for third quarter and second quarter 2012 were up 1% and flat, respectively. While these figures may seem unimpressive, readers should keep in mind the weak macro environment and high unemployment rate have constrained demand for office supplies.
- According to a national research survey, Office Depot (NYSE: ODP), Staples, and Zappos.com ranked the highest for speedy delivery service. Orders on average are delivered within 1 business day of purchase, which should help drive growth and retain existing customers. Industry experts indicate delivery time is the #1 indicator of customer satisfaction. Orders from Amazon.com took an average of 3 days 15 hours, according to the same study.
- Notable value investor Karen Finerman of Metropolitan Capital Advisors held 37,937 shares of Staples as of Sept. 30. I will inform readers if Finerman held Staples through Dec. 31, as her firm should disclose its year-end holdings within 45 days into the New Year.
- On December 20, an institutional investor sold 3,000 March $12 puts in Staples for $0.90. Selling puts is a neutral to bullish options strategy when an investor believes a stock can maintain its current share price or move higher over time. This particular investor believes Staples will exceed $12 in share price by March 15, 2013, and if the stock is below $12, the investor is willing to own shares at an adjusted price of $11.10.
Let's evaluate some of the weaker spots in the fundamental story on Staples. Management provided a comprehensive strategic review on Sept. 25, outlining plans to decrease store count within North America and improve square footage utilization within existing stores. Normally, discussions related to restructuring and cost containment have a negative effect on share price. Staples is also moderately correlated to GDP growth in the United States, and the company's printing sales could be affected by a decline in commercial paper usage.
With respect to valuation, Staples is currently trading at a record low 4.0 times enterprise value / EBITDA.
| Â | Staples, | Office Depot, | OfficeMax, | Amazon.com, |
| Market capitalization ($) | 7.7 B | 0.9 B | 0.9 B | 113.6 B |
| Beta | 0.9 | 3.4 | 2.6 | 0.9 |
| Ann. Dividend/Yield | $0.44/3.96% | -- | $0.08/0.82% | -- |
| Short Interest | 12.7% | 10.2% | 10.5% | 2.5% |
| Gross Profit Margin | 26.8% | 30.5% | 25.6% | 23.7% |
| Operating Profit Margin | 2.7% | (0.33%) | 10.74% | 0.93% |
| Net Profit Margin | 0.13% | (0.45%) | 6.48% | 0.28% |
| Enterprise Value | 8.1 B | 1.0 B | 1.4 B | 105.8 B |
| EV / EBITDA | 4.0x | 2.6x | 6.9x | 50.7x |
The 12.7% short interest indicated in Staples is likely betting on further margin declines within the company's North American Retail segment. In my opinion, however, the current valuation more than reflects a weak economic environment. Earnings appear to be stabilizing based on the most recent quarter and management guidance. Investors earned a small victory in November when management met expectations for the third quarter.
Furthermore, Staples has been successful in maintaining its leadership position within office products by offering the highest level of customer service and without the need for discounting / promotional pricing. If history serves as an indicator of future success, Staples has been extremely resilient despite attempts from Office Depot, OfficeMax, and now Amazon Supply to gain market share.
Foolish Bottom Line
While it wasn't easy being a Staples shareholder during 2012, I do not feel the company meets the definition of a classic value trap. Management is committed to improving productivity within its brick-and-mortar retail stores and its online delivery business appears to be growing despite the launch of Amazon Supply. Overall, I feel downside is limited. The company's 4% dividend yield is protected by strong free cash flow and should help put a floor under the stock price.
On the upside, shares should move higher into the mid-teens once the market realizes that Staples is able to protect its market share and profit margin within office supplies. The company's free cash flow yield of nearly 15% is one of the highest among publicly traded retailers, and the current 4.0x EV / EBITDA multiple is nearly half the retail industry average. Investors will learn if the discounted valuation is warranted when Staples reports full-year fiscal 2012 earnings in early March.
For readers interested in Office Depot or OfficeMax (NYSE: OMX), the latter has a significantly healthier balance sheet and its business prospects appear to be improving. In contrast, Office Depot reported a disappointing quarter in November and its cash flow is showing signs of weakness. Among the group, Staples is my first pick and OfficeMax the second.
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