Staples' Increased Focus on E-commerce Means Fewer Stores

Staples (SPLS) is on a quest to reinvent its business, and part of its strategy revolves around closing several dozen of its retail locations. In its latest earnings report, Staples CEO Ron Sargent mentioned that the company generates almost half of its sales online, a sign of the importance of e-commerce to long-term sales growth. The company is also working on reducing costs and improving efficiency.

Staples reported fiscal 2013 fourth quarter EPS of $0.33, which missed market estimates by $0.06. While the company met earnings estimates during the third quarter, lower earnings than expected were noted in the first, second, and fourth quarters of fiscal 2013, marking somewhat of a trend. Despite total sales dropping almost 11%, the more conservative GAAP diluted EPS figure grew 136% from $0.14 in the fourth quarter of 2012 to $0.33 in 2013's fourth quarter. Other GAAP figures show improvements from 2012 to 2013, a sign that the business is improving.   

While total sales for Staples decreased, Staples.com recorded 10% higher sales during the fourth quarter. The company also significantly increased its product selection during the quarter and changed its selling model to move the business beyond its bread-and-butter office supply product lines. Staples was able to reduce costs during 2013 and achieve profitability for the year in Europe.

Part of the reason for the negative sales growth was the closure of 63 stores during the 12 months prior to the fourth quarter of 2013. The company also reported that more store closures are coming: 225 North American stores will close their doors by 2015. A cost reduction program expected to yield $500 million in savings has been set in place. Lower comp store sales, which exclude sales in Staples.com, reflected lower traffic and smaller average orders compared to the prior period. Diluted EPS for the first quarter of 2014 is estimated to range between $0.17 and $0.22 .

Rival Office Depot completes merger with OfficeMax
The earning report sent Staples' shares sliding 15% to $11.35. Rival office supply chain Office Depot (ODP 0.34%) was also affected; its share dropped 5.7% to $4.63. In its full-year 2013 earnings report, the company discussed the completion of the merger with OfficeMax; the reorganization was completed in February. The combined company is expected to bring in cost synergies of more than $600 million by year-end 2016. Similar to Staples, Office Depot is focusing on streamlining its operations and improving profitability and return on invested capital.

As Office Depot and Office Max integrate their companies, there's were some store closures but not at the level of its rival Staples. During the fourth quarter, 16 Office Depot locations and seven OfficeMax stores were closed. The company ended 2013 with 1,912 stores in North America; 1,089 Office Depot stores and 823 Office Max stores .

E-commerce key to long-term growth
In late December, Office Depot was looking for a new executive to head e-commerce. According to Internet Retailer, Office Depot's 2012 web sales were $7.26 billion and trailed Staples, which reported $10.3 billion in online sales. As Office Depot builds up its online presence, Staples is way ahead of its rival. Mention has been made on providing customers with "multichannel options," but its unclear what Office Depot's online strategy will be. The recent merger and the resulting economies of scale could help the company carve out an online strategy.

Meanwhile, Staples' success in e-commerce also means providing customer service that is up to par with the likes of Amazon.com (AMZN -0.16%) and its many customer friendly services such as Amazon Prime memberships and Sunday package deliveries . Staples played a price matching game with Amazon during the holidays, so it's serious about competing with the online giant.

Staples' combination of e-commerce site and physical stores may be attractive to customers who may prefer picking up orders at their local store. While Amazon sells everything under the sun, Staples focus on the needs of business customers can work to its advantage. As far as investors are concerned, Staples has a more reasonable valuation than and similar 5-year PEG ratio as Amazon:

Source: Yahoo Finance

My Foolish conclusion
Staples seems to be making a smart move by redirecting its focus to its thriving e-commerce business. Close rival Office Depot must play catch up or risk losing business to retailers with a more established online presence. While Staples' shares are down about 25% since the start of the year, its decision to close several of its stores should improve the company's cost structure and efficiency. Its switch to smaller stores and expansion of its online product offerings for business customers may prove to be a winning combination for the retailer.