Is Staples, Inc. on an Unstoppable Decline?

After being hit hard on earnings, things look anything but great for Staples. Is now a time to buy the company's stock or will it and, possibly, Office Depot, keep spiraling down?

May 26, 2014 at 9:38AM

Dcusagallery

Source: Wikimedia Commons. 

After reporting revenue and earnings for its first quarter, shares of Staples (NASDAQ:SPLS) fell almost 13% to close at $11.71. Despite being hammered by Mr. Market on worse-than-anticipated results, is it possible that Staples (with its shares trading at a 32% discount from their 52-week high) is a bargain or should investors consider a stake in Office Depot (NASDAQ:ODP) instead?

Staples beat on revenue but couldn't keep its profits up!
For the quarter, Staples reported revenue of $5.65 billion. Although this represents a 3% drop compared to the $5.81 billion management reported the same quarter last year, the company's top line came in just above the $5.62 billion analysts anticipated.

According to the earnings release, its sales suffered because of falling sales in both its domestic and international operations. In its international operations segment, sales dropped 4% from $1 billion to $964 million, while its North American stores and online segment fared even worse with a 5% decline.

While comparable store sales fell 4% in the company's domestic market, its international segment saw comparable store sales come in flat despite the negative effect from foreign currency fluctuations and weakness in its European delivery businesses.

The only bright spot for Staples was its North American commercial segment. For the quarter, management reported an almost 1% gain in sales, which rose from $2.04 billion to $2.06 billion as products like breakroom supplies and furniture helped push sales up.

Even though Staples did OK from a revenue perspective, the company could not please investors when it came to profits. For the quarter, management reported earnings per share of $0.15. In addition to being 42% lower than the $0.26 the company enjoyed last year, its results were 29% below the $0.21 Mr. Market wanted to see.

Despite the fact that sales came in better than expected, Staples saw its profits miss forecasts because of higher costs across the board. On top of seeing its cost of goods rise from 74% of sales to 75.1%, the business also reported that its selling, general and administrative expenses jumped from 20.9% of sales to 21.6%.

Impairments and restructuring charges also played a roll in Staples falling profits, which, in aggregate, came in around $35.3 million for the quarter. Had its cost of goods and SG&A expenses remained the same as a percent of sales (and had the company not incurred any impairments or restructuring costs), earnings per share would have come in around $0.28 for the quarter.

Office

Source: Wikimedia Commons. 

But is Office Depot any better?
Over the past five years, Staples has struggled. Between 2009 and 2013, the company saw its revenue fall 5% from $24.3 billion to $23.1 billion while its net income declined 16% from $738.7 million to $620.1 million. In addition to being negatively affected by falling comparable-store sales in recent years, Staples' decision to reduce store count by 3% also impaired its performance.

As sales have fallen, net income has been hit especially hard. Over this five-year period, Staples has seen its cost of goods rise from 73.1% of sales to 73.9%, while its loss from discontinued operations ballooned to $86.9 million as the company focused on restructuring its operations.

In light of the problems Staples has faced, Office Depot might make for an interesting alternative. Over the past five years, the home office retailer saw its sales drop a whopping 7% from $12.1 billion to $11.2 billion but the company's annual net losses narrowed significantly, rising from a loss of $596.5 million to a loss of $20 million.

SPLS Revenue (Annual) Chart

Source: Staples revenue data by YCharts.

According to the company's most recent annual report, the business has seen its store count rise 61% from 1,289 retail outlets in 2009 to 2,075 by the end of 2013. At first glance, this may seem like a bullish indicator, but between 2009 and 2012, the company's store count actually fell 4% to 1,235. In 2013, the business added a significant number of locations to its roster through its acquisition of OfficeMax.

Excluding the sales generated by these locations, Office Depot's revenue would have fallen 15% over the past five years, from $12.1 billion to $10.3 billion. Also, removing the $382 million gain on the disposition of its Mexican assets and factoring in a 35% tax rate, Office Depot would have reported a net loss of $423.2 million for 2013. While this is still better than the company's loss five years earlier, it suggests that its bottom line hasn't improved as much as some had hoped.

Final takeaway
Right now, it's pretty clear that Staples is in a bit of a rough spot. Although it's possible that the company's situation may improve, the fact that it announced up to 80 store closings set for its second quarter (on top of the 16 locations shut down during the first quarter) suggests the opposite.

Office Depot makes for an interesting alternative, but when you parse through its financials, the company's position looks even worse than it does at Staples. While this does not rule out either business as an attractive long-term prospect, it does imply that both are quite risky and that it may be better for investors to look elsewhere for strong prospects.

Will this stock be your next multi-bagger?
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Daniel Jones 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.

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