Source:  Staples

It doesn't take a rocket scientist to realize that things are tough in the office-supply sector, a business that has been easy prey for cut-throat online competition. Even the federal government has realized that times have changed since its successful blockade of a Staples (SPLS)-Office Depot (ODP 0.49%) merger in the mid-1990s; it chose not to challenge the 2013 merger between Office Depot (ODP 0.49%)and OfficeMax, the No. 2 and No. 3 industry players.

The latest evidence of tough times was industry sales leader Staples' (SPLS)poor results in its latest fiscal quarter, a report that led to a subsequent double-digit plunge in its share price. However, with a current P/E multiple of roughly 11, Staples is now looking pretty appetizing for value-oriented investors. So, is the company a good bet at its depressed price, or should investors consider complimentary businesses, like FedEx (FDX 0.30%), that benefit from the office supply space?

What's the value?
Staples may have lost its sector kingpin title to Office Depot last year, but it still has a formidable national network of more than 1,800 stores, which are complemented by an international footprint of almost 300 stores located in 23 countries.  The company also has a major presence supplying office supplies to the business-customer segment through its Staples Advantage and Quill brands. 

Unfortunately, Staples' size hasn't allowed it to overcome consistent downward margin pressure. This has been the result of both hyper competition in the office-supplies space and a well-publicized shift by consumers away from higher-priced laptop computers and toward lower-priced tablet computers, which produce less profit for the company.

As might be expected from the opening paragraph, Staples' results in FY 2013 were not very noteworthy; this was highlighted by a 5.2% top-line decline that was primarily a function of lower comparable-store sales across its domestic and international markets.  More importantly, heavy promotions and a consumer shift toward lower-priced products led to a lower merchandise margin for the company, helping to produce a steep drop in adjusted operating profitability. 

The net result for Staples was reduced operating cash flow, negatively impacting its ability to invest in a more diverse inventory assortment, including newer forays in breakroom and medical office supplies categories.

Misery loves company
Of course, things do not look much better on the other side of the fence at Office Depot.  While the company reported an overall top-line increase for FY 2013, up 5.2%, all of the largesse was due to the addition of OfficeMax's sales tally rather than an increase in organic sales.  Absent the merger, Office Depot would have reported a 3.6% sales decline, in line with the performance at Staples.  On the upside, though, Office Depot has identified roughly $600 million in cost synergies from the tie-up, which should allow the company to improve its current razor-thin operating margin and improve its chances of long-term survival.

Looking better as a side business
While Staples has been pulling levers in a bid to improve customer traffic and sales growth, including the addition of 3-D printer kiosks in a subset of its stores, it is hard to envision the company returning to the heady growth days of prior years. As such, investors looking for an office-supply play should be focused on competitors that participate in the sector as a complementary side business to their core operations, like FedEx(FDX 0.30%).

The shipping giant participates in the office-supply space through its national network of FedEx Office stores, a consequence of the company's 2004 acquisition of copy-center pioneer Kinko's.  However, FedEx's bread-and-butter business is obviously shipping, a sector that it dominates along with larger competitor UPS. 

Top-line growth has been hard for FedEx to achieve in FY 2014. But FedEx's consistent profitability in its overall shipping business provides strong cash flow to fund its ancillary business activities, including its Office store network, which primarily act as additional sales channels for its larger shipping business rather than as separate profit centers.

The bottom line
Staples is undoubtedly a cheap stock, trading at a below-market P/E multiple of approximately 11. Unfortunately, that is probably because Mr. Market has very little faith in a profit growth story for Staples, a reasonable conclusion based on the company's performance in 2013. Until Staples can find a way to attract rising customer volumes, likely through the addition of more service offerings in its stores, investors should avoid this value trap and look to FedEx instead.