Can Staples Find Some Mojo by Partnering With Steelcase?

Office supply retailer Staples has been trying to turn its slumping stock price around, announcing a number of new product introductions in its stores, including an enhanced assortment of furniture from Steelcase. Is it time to catch this falling knife?

Jun 11, 2014 at 11:23AM

Source: Staples.

Nothing has been working in office supply giant Staples' (NASDAQ:SPLS) favor lately, as evidenced by consistent declines in sales and operating profit, a trend that has also negatively affected other industry players, including Office Depot (NASDAQ:ODP). The company's latest financial update revealed another poor performance, highlighted by a sharp drop in adjusted operating income, which led to a subsequent double-digit decline in Staples' struggling share price.

Despite the challenges, though, management continues to try out new ideas in a bid to turn things around, most recently partnering with furniture giant Steelcase (NYSE:SCS) to offer a greater selection of office furniture in its stores. So, after shares plumbing a 52-week low, is now the time for investors to bet on Staples?

What's the value?
With more than 1,500 domestic stores, Staples has long been a leader in the office supply space. While online and mass-merchandising competitors have anecdotally stolen market share away from the company in the traditional office supplies categories, Staples has limited its overall sales declines by broadening its inventory selection, including newer forays into furniture and breakroom supplies areas. Unfortunately, the gross margin on those categories doesn't seem to be any better than the margin on traditional office supplies, as evidenced by a general downward trajectory in the company's overall gross margin over the past five years.

In its latest fiscal year, Staples' business continued its recent negative trajectory, highlighted by a 5.2% top-line decline that was a function of sales decreases across the company's major segments. Just as important, Staples' gross margin continued to be pressured by a highly promotional selling environment, which conspired to produce a double-digit decline in its operating income.

On the upside, though, Staples' commercial segment, home to its Staples Advantage and Quills brands, bucked the negative trend, generating a slight increase for the period. In addition, Staples benefited from its introduction of various cost savings initiatives, including the proposed closure of approximately 225 stores, which are cumulatively expected to save the company up to $500 million per year. The net result for Staples was a continuation of solid operating cash flow, easily funding its capital expenditures and enabling the company to engage in shareholder-friendly activities, like share repurchases.

Going forward, Staples will also undoubtedly be helped by Office Depot's 2013 acquisition of OfficeMax, a transaction that eliminated the No. 3 industry player. While Office Depot is still in the process of integrating the two companies' operations, its management team has indicated that it plans to close at least 400 stores across the country, an action that could potentially be a boon for Staples' traffic and sales in those affected areas.

Looking for growth anywhere
Of course, cost cuts can only take Staples so far, which is why management is focused on bulking up its inventory assortment, hoping that the strategy will bring greater volumes of customers through the doors. A big part of that strategy seems to be an enhanced presence in the furniture category, a key product area that already accounts for roughly 6% of its total sales. If that is the case, Staples seems to have hit the jackpot by partnering with Steelcase, one of the country's largest manufacturers of office furniture and the owner of a diversified portfolio of popular brands, including Steelcase, Coalesse, and Turnstone.

The bottom line
Mr. Market doesn't seem to be too impressed with Staples' recent business changes, pushing the company's share price down near its 52-week low. While the changes, including a reduction in the company's overhead cost structure and the size of its store footprint, will likely lead to a more profitable enterprise, there seems to be little faith in Staples' ability to arrest its continuing decline in sales. This view seems to be corroborated by Staples' financial performance in its latest fiscal quarter. As such, rather than trying to catch a falling knife, investors might want to take a pass on Staples in favor of Steelcase, which has been enjoying a profit lift lately thanks to improved product pricing, and should benefit from the greater distribution and sales opportunities within Staples' network of stores.

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Robert Hanley owns shares of Office Depot. 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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