Why Now Is the Time to Buy Staples

Staples is no longer the second-largest e-commerce vendor, but that doesn't matter. The company has plenty of initiatives to spur growth over the long term.

Jun 17, 2014 at 12:27PM

When Staples (NASDAQ:SPLS) reported its first-quarter results on May 20, the company revealed that comparable-store sales fell 4% in the period, with store traffic also down 4%. Operating income dove 270 basis points to 3.5%, as sales at North American stores and online sales fell 4.9% to about $2.6 billion.

Just two weeks prior to Staples' earnings announcement, The Wall Street Journal  reported that Apple overtook Staples to occupy the No. 2 spot on the list of the largest e-commerce retailers.

With shares of Staples beaten up and lagging the return of the S&P 500 index by a large margin, now might be a good time to pick up some shares of Staples. Here's why. 

Focus on the positive
Staples' copy and print same-store sales in North America grew in the high-single digits, while online copy and print sales were in the double digits following improvements to Staples' website.

Staples' successful division should continue to differentiate itself not only from online retailers but also brick-and-mortar competitors, especially following its acquisition of PNI Digital Media in early May. PNI Digital Media is a software company that allows retailers to offer online printing, photo kiosks, personalized cards, and much more.

Positive aspects of Staples' business include rapidly growing segments such as facilities, cleaning and the standout segment of breakroom supplies which is seeing double-digit growth.  Staples' President of North American stores explained during the company's first quarter conference call :

The headline stars on cleaning and breakroom and it's going to success for all channels at Staples. We are excited to have it, expand in stores as well. In the first round, I mean, just keep in mind, we started this just a couple of months ago. Based on average frequency of trip most customers haven't seen these and appreciated these reflows yet. So we are still waiting for customers to make repeat trips into the store, but I would say instantly good response on cleaning and breakroom as well as some of the other categories that we've grown. , which could help offset declines in other categories.

Staples is investing in increasing its sales force to add specialists who can offer customers a better overall shopping experience in specific categories.

Staples has demonstrated a commitment toward allocating funds to successful segments at a time when the company is committed to saving $500 million in selling, general, and administrative expenses over three years. The company has already identified areas where it can save $100 million in 2014. In fact, it guided for savings of $250 million in 2014.

During Staples' first-quarter conference call, Christine Komola, the company's chief financial officer, confirmed it is working hard on lowering costs wherever appropriate:

So we've identified things and have things in process related to store labor models, related to procurements, IT contracts, marketing which we've talked on. And I think that as you think about the investments that we've continued to make[,] that also ramps up over time. So, sales [the] force takes time to pay off[,] as we talked about[,] between 12 and 18 months. So [we] feel good about the progress[,] and we are definitely [in] the early stages.

Leaner and just as good
Staples announced during its first-quarter conference call that it is currently operating 33 new 12,000 square-foot stores, which retained 95% of sales of a larger format store. The company guided toward downsizing and relocating an additional 25 stores to the new 12,000 square foot format during 2014.

During the first quarter, Staples closed 16 stores and it plans to close an additional 80 stores during the first quarter.  In addition, 40 more closures are expected in the back half of 2014. The stores the company will close are lower-volume stores with lower margins and typically larger stores of 19,000 to 20,000 square feet.

As the company continues to examine its store model and identify ways to improve it, it could achieve 95% of its original sales while realizing a substantially reduced rent expense.

Unfortunately, Staples management does not offer guidance toward full-year rent expenses. In fact, the only full-year guidance Staples offers is for $600 million in free cash flow, which includes $60 million to $100 million as a result of restructuring and other related activities.

The lack of guidance is due to Staples' continued investments and its transformation to become a leaner and more efficient retailer.  Staples is not focused on quarterly (or yearly) metrics that don't paint an accurate picture of the long-term potential.

Meanwhile, Office Depot (NASDAQ:ODP) guided toward closing at least 400 stores in the U.S. by year-end 2016, which will save $75 million annually.

It is important to point out that Office Depot said that its store closings will amount to "at least 400 stores," while Staples management guided toward closing "as many as 225" stores over the same two-year period.

Investors should consider the fact that Staples appears to be approaching its store closures and relocations more cautiously through relocating stores to smaller yet almost equally productive formats.

Foolish take
Investing in either Staples or Office Depot is a long-term commitment, as there will certainly be short-term bumps in the road ahead as both companies take the necessary steps to improve their businesses.

Shares of Staples continue to trade near their 52-week lows, while Office Depot has seen a nice rebound since April. It appears as if investors are buying into Office Depot's turnaround story more than they are buying in to Staples' turnaround story.

This would be an error, as Staples holds the key advantage in being the substantially larger e-commerce player; as Foolish analyst Adam Levine-Weinberg accurately points out in his Office Depot article, "[Staples] has the advantage of stability, whereas Office Depot is in the midst of a complex merger integration process."

As both retailers race toward reinventing themselves for the long haul, investors should naturally stick with the player that has the stability advantage.

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