Should You Hit the Easy Button and Buy Staples?

Office-supply retailer Staples has not been the place to invest in 2014, with its share price down sharply. However, with a below-market P/E multiple, is it time to buy in?

Jul 24, 2014 at 12:10PM

Source:  Wikimedia Commons by Anthony92931

Shareholders in office-supply giant Staples (NASDAQ:SPLS) have continued to sing the blues in 2014, thanks to a poor performance for the company's share price, down almost 30%. Staples continues to be negatively affected by lower customer traffic volumes, a trend that is also in vogue at competitor Office Depot (NASDAQ:ODP). Case in point was the company's latest fiscal quarter, which was marked by lower comparable-store sales and worse-than-expected profitability, a performance that led to a subsequent sell-off in its share price.

However, with a P/E multiple of roughly 12, Staples is looking like a good bargain to some, including prognosticators at Barron's who highlighted it among a handful of beaten-down retail companies. So, is Staples a good bet at current prices?

What's the value?
Staples is one of the kings of the office-supply sector, with a network of roughly 1,500 stores across the country complemented by a smaller network in select international countries. Unfortunately, that significant scale has proven to be of little value lately, anecdotally due to the ability of mass merchandising and online competitors to underprice the company and steal portions of its customer base.  The net result for Staples has been a downdraft in its revenue and operating profit over the past five years.

In its latest fiscal year, it was the same story for Staples, highlighted by a 5.2% top-line decline that was a function of lower sales across its major business units. More importantly, the company's profitability took another step backwards, due to product pricing pressures and lower sales productivity in its retail network. Not surprisingly, Staples' operating cash flow also took a hit during the period, though it remained at a solid level more than capable of funding the company's capital expenditures.

On the upside, Staples continued to show positive momentum in its services business, an area that accounted for roughly 7% of its total sales in its latest fiscal year. While the company has long provided copy/print services in most of its stores, it is attempting to drive even more growth in the services arena through innovative partnerships, like its deal with 3D Systems that will add 3-D printing services to a small subset of its stores.

In addition, Staples' sales have likely received some benefit from Office Depot's merger with No. 3 office-supply chain OfficeMax in 2013, a deal which was predicated on the belief that the country had a surplus of office-supply stores, negatively impacting the profitability of all the industry's players. 

Indeed, Office Depot recently stated a desire to close 150 stores in 2014 and 400 stores over the long run, approximately 20% of its North American store base. Some of those stores' sales will go to other competitors, but Staples should undoubtedly be able to pick up its fair share of sales through its nearby locations.

Waiting on profit growth
Of course, the question for investors is when Staples will start to show some sustainable operating profit growth, thereby providing a solid foundation for a higher market valuation. Unfortunately, it is unclear when that will be, given that the company is in a price-matching war with its competitors, including Wal-Mart Stores (NYSE:WMT).

The discount retailing giant has anecdotally been investing in a broader assortment of office-supply categories and has been using its massive buying power to meet its goal of offering the lowest prices in each of its markets. Wal-Mart has also been upping its game in the price-matching arena, recently unveiling its Savings Catcher website that automatically compares advertised prices to the prices its customers paid on purchases, refunding any difference to customers through its store-credit system. All told, it adds up to a more competitive landscape for Wal-Mart's smaller competitors, like Staples.

The bottom line
In 2014, Mr. Market has been hitting the sell button with regard to Staples, driving the company's share price down sharply. However, he may be throwing the baby out with the bathwater, given Staples' history of profitable operations and its solid cash-flow profile, not to mention its growing potential as a technology-services provider. While profit growth may still be a ways off, the company is a worthwhile bet at its current below-market valuation.

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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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