Thursday, February 18, 1999
DJIA 9254.12 +58.65 (+0.64%) S&P 500 1230.59 +6.56 (+0.54%) Nasdaq 2253.30 +4.39 (+0.20%) Russell 2000 389.53 -0.10 (-0.03%) 30-Year Bond 98 21/32 -13/32 5.34 Yield

An Investment Opinion
by Louis Corrigan

Office Depot Makes Dilbert Proud

Leading office products retailer Office Depot (NYSE: ODP) tacked on paper profits of $3 1/16 to $33 15/16 this morning after reporting adjusted Q4 earnings of $0.34 per share, up 31% from $0.26 per share a year ago and a penny ahead of the consensus estimate. Revenue increased 10% to $2.3 billion driven by a 5% jump in sales for its 601 stores and 31 delivery centers open for at least a year. Revenue for all of FY98 rose 11% to $9 billion on 7% comp-store gains, dropping $1.24 per share in black ink to the bottom line, an increase of 28%. These figures exclude $86.8 million in charges, net of tax benefits, related to the company's megamerger with Viking Office Products last summer.

Two operating numbers stand out. Gross margins in the period soared to 29.9% from 27% and inventory actually dropped by a remarkable 10% despite the sales growth and new store openings. By concentrating on its leading suppliers and enhancing its computerized supply chain management, Office Depot dramatically improved its asset management. Also, while the Viking merger initially created some integration challenges, particularly with respect to the company's California warehouses, centralized purchasing is paying off in higher margins, as expected.

The superstore chain is focusing more on growth, too. After opening just 41 stores in 1997 amidst the government-aborted merger talks with arch rival Staples (Nasdaq: SPLS), Office Depot added 100 stores last year (68 in Q4) with plans to roll out 105 units throughout 1999. In-store merchandising initiatives, such as new wireless communications centers and enhanced technology offerings, are helping to drive sales, too.

Still, I now see the world through the eyes of e-commerce, and what stands out is Office Depot's ridiculous 28% FY98 gross margin. This number offers some aggressive online vendor a Texas-sized price gap to drive through. Granted, the company's enormous buying power and savvy management accounts for some of that, but Office Depot's low prices are still too high.

In a January 4 survey of the nation's top 100 retailers, Computer Retail Week put Office Depot #3 in retail computer sales at $2.9 billion, or about 32% of the firm's overall revenue. With the introduction of Onsale's (Nasdaq: ONSL) AtCost site, and others sure to come, a third of Office Depot's business will come under gross margin assault. Moreover, I love my Expresso pens, but I bet the wholesale price is considerably lower than $9.99 a box. Office Depot has an excellent website offering personalized features like customizable shopping lists. It also offers free next day delivery on orders of more than $50 placed within one of its local trading areas. Its built-in distribution system is surely one reason why the company's Internet sales hit $29.4 million in Q4 and $66.5 million for the full year.

Still, many office products are repeat purchase items. An office manager makes a list of the SKU numbers for these products and just reorders periodically. With these items in particular, price matters, and some enterprising e-tailer will eventually address this market with a vengeance. As unit prices contract, Office Depot's revenue growth will be even harder to come by. At 22 times the current FY99 earnings estimate of $1.51 per share, Office Depot might look like a modest value. But like other major hard goods retailers, the company has only begun to grapple with what the Web might do to its business.


U.S. financial services company Transamerica Corp. (NYSE: TA) jumped up $15 11/16 to $73 5/16 after Dutch insurer Aegon NV (NYSE: AEG) agreed to buy the company for $9.7 billion in cash (30%) and stock (70%), representing a 35% premium over Transamerica's closing price yesterday of $57 5/8. In addition, Aegon will assume about $1.1 billion of Transamerica's debt. Aegon added $5 1/8 to $99 7/8 this morning.

AT&T (NYSE: T), which won the blessings of federal regulators regarding its acquisition of cable operator Tele-Communications Inc. (Nasdaq: TCOMA) and thus cleared the final major hurdle to the deal, took on $1 9/16 to $85 7/8. The companies' shareholders voted to approve the transaction yesterday.

Waste services company Superior Services (Nasdaq: SUPR) canned a gain of $1 3/4 to $19 1/2 after Morgan Stanley Dean Witter analyst Brad Galko upgraded the stock to "outperform " from "neutral," setting a $22 per share target on the shares. "Management has begun to execute on its new strategy of more disciplined growth," the brokerage said, "giving Brad increased confidence in his EPS estimate of $1.20 for 1999,'' which is a penny below First Call's consensus estimate.

Computer-based medical diagnostic equipment maker Elscint Ltd. (NYSE: ELT) added $1 3/4 to $13 5/16 after majority owner Elbit Medical Imaging Ltd. (Nasdaq: EMITF) announced the intent to buy the rest of the company's shares for $14 in cash each, a 21% premium over yesterday's closing price. Elscint has yet to respond to the offer.

Streaming media aggregator Broadcast.com (Nasdaq: BCST) ran up $10 15/16 to $69 1/8 after Donaldson, Lufkin & Jenrette analyst Jamie Kiggen raised his rating on the shares to "buy" from "market perform," upping his price target to $100 per share from $40.

Telecommunications services company CoreComm Ltd. (Nasdaq: COMMF) dialed up a gain of $6 to $27 3/8 after it announced the purchase of privately held Megsinet Inc., an Internet network and regional telecommunications provider, for $18.5 million in cash and 1.5 million shares of common stock.

Personal care products network marketer Nu Skin Enterprises (NYSE: NUS) took on $3/4 to $22 after a Utah federal judge said the company can market Cholestin, a nutritional supplement developed by its Pharmanex subsidiary, without the FDA's regulation of the substance as a drug. The ruling reverses a May FDA decision.

Biopharmaceutical company The Liposome Co. (Nasdaq: LIPO) rose $1 1/8 to $12 after it said the FDA accepted its new drug applications (NDA) for Evacet, a form of the doxorubicin anticancer drug. The company hopes to earn full FDA approval for the drug within the year. Liposome also announced the initiation of Phase I trials of TLC ELL-12, another cancer fighter.


Gold producer Barrick Gold (NYSE: ABX) dropped $3/4 to $17 15/16 after announcing it will buy all outstanding shares of Canada-based exploration company Sutton Resources (Nasdaq: STTZF) in a stock swap valuing Sutton at C$525 million, or C$13.25 a share. Sutton's shares shot up $3 15/32 to $8 3/32 on the news.

Dialysis centers operator Total Renal Care Holdings (NYSE: TRL) plunged $11 7/16 to $9 9/16 after reporting lower-than-expected fourth quarter earnings of $0.30 a share, up from $0.19 a year ago. Analysts had projected EPS of $0.37.

Travel Services International (Nasdaq: TRVL) sank $6 5/8 to $15 3/8 after warning it expects net revenue growth in the first quarter of this year to be slower in certain areas than the company's aggressive growth targets.

Analog integrated circuits maker Sipex Corp. (Nasdaq: SIPX) tumbled $10 1/8 to $13 11/16 after warning that it remains "cautious" about its short-term revenue outlook as "continued uncertainty in the world markets are [sic] impacting our customers' ability to predict demand for their products."

After soaring in its first two days of volatile trading, nutritional supplements company Mannatech Inc. (Nasdaq: MTEX) lost $7 1/4 to $24 1/2 this morning. Yesterday the company's shares plunged 50% but then rose and ended the day 41% higher. The stock was initially priced at $8 a share.

Healthcare information technology firm QuadraMed (Nasdaq: QMDC) slid $4 3/16 to $18 7/8 after posting Q4 EPS of $0.29 (before one-time items) versus $0.15 last year. Analysts had expected EPS of $0.28.

MSC Industrial Direct
(NYSE: MSM) fell $2 5/16 to $21 3/4 after Prudential Securities downgraded the company's shares to "accumulate" from "strong buy."


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