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Valuing Staples
The BMW Method

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By kelbon
July 20, 2007

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Staples (SPLS)

I spent much of the day today delving into the valuation techniques used by Joe Ponzio on his FWallStreet website.

How he evaluates the value of a company is based on Book Value + Discounted Free Cash Flows. HIs goal is a 15% return and buying that return at a 75% discount -- depending on the quality of the company.

There's a two-part blog on the site which evaluates Johnson and Johnson -- a BMW flavor of the month.

I found this valuation technique interesting because there is no reference to what the stock sells for, or has historically, at all. This eliminates any references to Price/Earning, Price/Free Cash Flow or Price/Book Value, or Price CAGR for that matter. It ignores Wall Street altogether and concerns itself only with the intrinsic value of the business. (Hence F Wall St?).

Having finally mastered (?) this valuation technique I was eager to take it for a test-drive. One stock that has been on my watch list is Staples. So, I took Staples for that test-drive. Assuming that my calculations are correct; according to Joe's formula, to get a 15% return on Staples (for the next 20 years!) would cost you $36.85 per share today. To add that 25% margin of safety discount would bring the price to $27.63. Staples is selling at just over $25.00 a share.

For BMWers: Staples is currently trading at about -0.68 RMS according to mkein's 16 year chart. No big deal, I know, but if the price were to increase to the average CAGR line this would represent a gain of nearly 25%. If Staples stock continued to appreciate at its average CAGR that would represent an additional CAGR of 19.65% into the future.

So what else does SPLS have going for it? Staples also appears on the MagicFormula Investing website as one of the top 100 large-cap companies with a market cap of over $2 million -- with a Pre-tax Earning Yield of 9%. This is indicative that given the company's efficiency and return on capital in relation to its stock price, it may be undervalued.

Staples is trading at a trailing p/e of about 19.5% and has hovered around this valuation since 2002. On the other hand its trading at about 12.8 times trailing cash flow. It hasn't sported a valuation that low since 2003.

Year by year Staples is eliminating its long-term debt and last year earning were three times debt. They have almost $1.5 billion in cash on their books (just over $2.00 a share.) This explains why last year their ROTC was 18% almost matched their ROE at 18.9% -- both impressive, but not stella, numbers. But over the years these ratios have been increasing from the mid-teens. LIkewise, the Net Profit Margin has been growing and stands at about 5.5% currently.

Staples has increased its Cash Flow and Earning per Share every year, without exception since 1991.

Value Line expects an annual return of 16 to 24% for the 2010-12 period, and say: " This stock offers attractive 3 to 5 year capital gains potential. Our projections indicate annual share-earnings gains of around 15% over the period. Staple's stock repurchase program, supported by estimated free cash-flow or $825 million this year, is a contributing factor."

However, whether Staples has a moat is debatable, but it seems to be way ahead of its competition. Many businesses, large and small, have accounts with Staples; in most cases it's not likely that the intern gets sent to Office Depot for this, that, and the other.

In summary:

� At a low RMS of -0.68, when taken in the context of a historical price appreciation CAGR of 19.65% Staples could be considered a buy at these prices.

� SPLS appears on the Magic Formula website indicating that the company is efficient and maybe a good value now.

* Based on Joe Ponzio's formula (fwallstreet.com) Staples appears to be about 25% undervalued. But I'll have to give more thought to this approach. Any feedback here would be welcome.

� Earnings per share have increased every year for the last ten years -- so there's a consistent earnings history.

� Strong financial position and a strong brand.

What I see is mainly positive and on a risk/reward basis Staples seems to be a buy. Now if only the stock-price would drop another 10%...


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