Another Dirt Cheap Stock

Despite the roller-coaster ride, there has been one good thing about this market: It's caused a bunch of stocks to get really cheap.

Now, I'm not necessarily talking about the high-profile losers. Washington Mutual (NYSE: WM  ) may be at or near 10-year lows, but big banks have huge headline risk. Their balance sheets are so opaque that it's unclear what these companies will look like after the subprime crisis has passed.

The cheap stocks I'm talking about aren't at ground zero of the housing bubble and credit crisis. They're being killed due to recession fears. These stocks aren't making headlines, but they have quietly become bargains. One of my favorites is Office Depot (NYSE: ODP  ) .

The business
Office Depot is an office products and services retailer with about $15.5 billion in annual revenue. You're probably the most familiar with its 1,500-plus stores worldwide. However, in addition to the stores, Office Depot has a direct sales division. This division -- which accounts for about 30% of the company's revenue -- not only sells to small businesses through catalogs and the Internet, but also targets larger companies using a direct sales force.

The company is big, but it's still growing. Over the past five years, Office Depot has been expanding its revenue by 6.5% and earnings by nearly 15%. Though the North American market may be nearing saturation, Office Depot plans to add 75 stores in 2008. This is still a growth story.

The competitive position
Retailing is a tough industry. Office Depot's biggest competitors are Staples (Nasdaq: SPLS  ) and OfficeMax (NYSE: OMX  ) . The three companies have similar store formats and product selection and have struggled against each other for years. While Staples has been the most successful, all three companies have grown over the past decade.

But these big-box stores are only a fraction of the competitive picture. The office products market is extremely fragmented -- Office Depot, Staples, and OfficeMax have only about 12% market share combined according to a recent report by Standard & Poor's. Other competition ranges from tiny mom-and-pop shops to Wal-Mart (NYSE: WMT  ) . Even Best Buy (NYSE: BBY  ) is a competitor -- more than one-fourth of Office Depot's revenue is derived from sales of technology products.

Yet Office Depot has a solid competitive position. It has a well-recognized brand, established customer relationships, a large distribution network, and stores in hard-to-duplicate locations. The fragmented market means that there is still room for the company to gain market share. Plus, Office Depot has excellent management. The company's CEO, Steve Odland, was at the helm of AutoZone (NYSE: AZO  ) from 2001 to 2005. He grew both market share and profits significantly during that period and tripled the share price. This guy knows retailing.

The valuation
Despite its growth potential and its competitive advantages, Office Depot is dirt cheap. It's trading for just over seven times trailing earnings and slightly more than its book value. The company has a solid balance sheet with a manageable amount of debt.

What's more, since 2005, Office Depot has repurchased shares and reduced its outstanding share count by 12%.

The risks
It's rare to get a good business this cheap, so when you see bargains like these, try to understand why the price has dipped. I see several reasons. First, Office Depot had a minor accounting restatement last year because of revenue recognition issues. But I don't consider this a major problem.

A more important factor is a potential 2008 recession. Office Depot has already felt the slowdown. A quarter of the company's retail sales comes from California and Florida, two of the worst-performing housing markets in the country. As a result, Office Depot's revenue growth has stalled. Both its same-store sales and year-over-year earnings declined last quarter. More recently, in mid-December, the company warned investors that its poor performance in these two states has spread to other parts the country.

The Foolish bottom line
The good news is that with these bargains, a lot of the bad news is already priced in. The business is solid, and in a few years, today's price will seem like a great deal, in my opinion.

Of course, Office Depot is just one of the excellent bargains available right now -- and it's a stock that we're investigating for our Inside Value investing service. And although Office Depot is an excellent stock -- I own it -- I think there's an even more compelling retail opportunity right now.

That opportunity was one of the top recommendations in our December newsletter. Read about it, and all our other picks, by joining Inside Value free for 30 days. There is no obligation to subscribe.

Fool contributor Richard Gibbons can simultaneously be greedy and fearful. He owns shares of Office Depot and the retailer recommended by Inside Value, but does not have a position in any of the other stocks discussed in this article. WaMU is an Income Investor recommendation. Wal-Mart is an Inside Value pick. Staples is a Motley Fool Stock Advisor selection. Best Buy is an Inside Value and Stock Advisor pick. The Fool's disclosure policy has got game.


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  • Report this Comment On February 27, 2009, at 8:56 AM, musicman157 wrote:

    This may have looked like a good risk a month ago when it was written. However, this stock has tanked considerably since Steve Odland took over. Two years ago the stock was in the 40's. Eveyone has taken a hit in this economy. Putting that aside, let's look at other factors:

    1. A few years ago Office Depot reported inflated numbers before the fourth quarter earnings came out. The entire board was replaced. I think that's when Steve Odland came in.

    2.About seven states have questioned the "bid low and sell high" tactics they have done to state contracts. Nebraska has pointed out that they were charged as much as 400 percent markupfor some items. Other states include Georgia, North Carolina, and Florida.These inquiries have not only lost business for Office Depot, but launched a federal investigation. OD has aknowledged they are being investigated.

    3. Have you been in an Office Depot lately? They are stuck with outdated computers and electronics. The staff is cut down considerably, and it is difficult to get help- sometimes even to ring up a sale.

    4. Last November (2008) Office Depot decided to purchase a more updated facility for it's home office. The price tag was $100 million. It is equipped with state of the art elevators, as well as a gym.

    Meanwhile, this month, they closed a distribution center in Florida, putting about 200 people out of work.

    5. The stock closed yesterday at $1.01 per share, down from $46.00 several years ago. If it goes below $1.00 they have 30 days to get it back up, or be off the stock market.

    Does this sound like a company you want to invest in? Does this sound like the management is making good, strong decisions? Does this sound like a company that will survive today's economy.

    I was seriously considering buying this stock at one point. Invest in Officemax or Staples.

    I am no expert by any means in the stock market, but I do watch my money carefully.

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