Staples (NASDAQ:SPLS), the office supplies big-box chain is taking its business model to the shredder. The ruler of office retail is waving the white flag as customers flee and sales decline all in the name of trying to "reinvent itself." Not only is the company troubled by the usual problems facing brick-and-mortar retailers in the age of the Internet, but many of its trademark products (paper, printers, etc.) have become obsolete as society moves to digital communication. Sales are declining, and the company failed for the first time in many years to raise its dividend recently. Long term, survival is far from guaranteed. Facing similar challenges, rivals Office Depot and Office Max recently merged in the hopes of shedding excess stores and returning to health.
Management knows it's in a jam, too. Over a year ago, CEO Ron Sargent announced a "plan to fundamentally reinvent our company." Among the steps the retailer has taken so far have been trimming its retail footprint, pushing online sales, and reinventing the brand through its "Make More Happen" campaign. In its last earnings report, Staples said it would close up to 225 stores in North America by the end of 2015 or about 12% of its total, and guided Q1 EPS below expectations at $0.17-$0.22 and down from last year's result of $0.26. Not exactly promising signs.
Sargent's efforts to revamp the company have been admirable, but Staples is up against some strong headwinds. In its most recent quarter, comparable sales fell 7%, and it was the eighth consecutive quarter that same-store sales have fallen . Considering management's plans to close another 225 stores after cutting more than 1 million square of retail space last year, it doesn't seem to expect comparable sales to turn positive anytime soon.
Instead, Staples seems content to stake its future on online sales. In 2013, it increased the number of products available on its website from 100,000 to over 500,000, and saw online sales growth accelerate to 10% in the fourth quarter, bringing in nearly half of the company's sales. There are a couple problems with this approach, however. First, the company launched its new "Make More Happen" campaign to support its online push as it wants to be the supplier to all sorts of business from grocers to veterinarians. The strategy moves away from Staples strength and brand identity as an office supplier, however, and risks confusing customers about what it stands for. The bigger problem, though is the effect on margins, which are slimmer in the more price-competitive online channel. Staples acknowledges just as much in its last earnings report, saying that operating margin fell 355 points to 6.07% in large part due to lower margins on Staples.com.
Not even cheap despite operational troubles
With sales in a secular decline and profits getting crunched from falling brick-and-mortar sales and lower margins in the online channel, you'd think Staples stock would be cheap, but that isn't the case.
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Based on earnings valuations, generally seen as the best way to measure the price of a stock, Staples is more expensive than Macy's on a forward basis, and only slightly cheaper than Wal-Mart.
Contrary to Staples, both Macy's and Wal-Mart's are expected to grow in the future rather than shrink. In its earnings report last week, Macy's said it expected EPS to grow by at least than 10% this year, and hiked its dividend 25%, while Wal-Mart, the world's largest retailer, also projected growth despite a disappointing start to the year.
Indeed, looking further into the future, the differences between the companies become even starker. By 2019, analysts project Macy's earnings per share will have grown more than 60% while Staples' is expected to be flat. A lot can happen between now and then of course, but the discrepancy is indicative of how different the two companies' competitive positions are today.
The challenges facing Staples are many. After two straight years of negative same-store sales growth, it seems almost inevitable that brick-and-mortar sales will continue to decline. Margins are likely to compress further as it expands its online sales, and the company risks losing its brand identity as it transitions away from retail and tries to be everything to all businesses. Considering the risks of owning Staples and the price of healthier companies in the retail sector, Staples stock seems significantly overvalued. Even if the company is able to successfully navigate a transformation, I'd expect further pain ahead in the coming quarters.
Jeremy Bowman has no position in any stocks mentioned. The Motley Fool owns shares of Staples. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.