Somewhere between the small-business owner deciding between a pair of fax machines and the weird guy clutching his red Swingline stapler, you'll find something odd at your neighborhood office supply superstore: Kids! Going through notebooks, loading up on inkjet cartridges, and upgrading their backpacks, kids are headed back to school.
Perhaps the effect is not so monumental as it is in apparel retail. But make no mistake, the dawn of the new school year is a boon to such business superstores as Staples (NASDAQ:SPLS) and Office Depot (NYSE:ODP).
It wasn't always this way. Before the two sprang on the scene in 1986, office supplies were considered small potatoes in consumer retail. Back then, companies loaded up at mom-and-pop supply shops or used direct vendors like Buhrmann's (NYSE:BUH) Corporate Express. But just like Blockbuster (NYSE:BBI) capitalized on a fragmented video-rental sector ripe for supersizing, Staples and Office Depot cashed in on their large-box concepts.
And by cashed in, I mean cashed in. Along with Office Max (NYSE:OMX), the three largest office-supply chains rang up sales of $27.8 billion last year. When these guys set up shop, you better believe they mean business.
Staples
That was easy. That's the new slogan at Staples, and investors are probably feeling it after watching their shares double off last year's lows. With 1,500 locations worldwide, the largest of the office-supply chains is delivering results. Earlier this week the company posted excellent second-quarter earnings. Profits shot up 47% on a healthy 6% uptick in same-store sales.
Last year, the company took the initiative to shift its attention away from the casual consumer in favor of the more lucrative corporate power customer, which has helped grow results at the store level. Staples also made some strategic acquisitions to beef up its delivery business. Given the larger orders and lack of in-store fulfillment, margins are fatter for delivery than for walk-in traffic.
Staples now expects to earn $1.09 a share this year. Meanwhile, its move toward selling more store-brand supplies boasts a pair of fundamental benefits. First, it creates product loyalty for items carried exclusively at Staples. Second, the margins are wider than they are on someone else's wares.
Office Depot
Office Depot may only have 870 North American stores, but they pack a punch. The company generated $11.4 billion in sales last year, a few baby steps shy of Staples' $11.6 billion tally. And the battle is escalating: Both Staples and Office Depot recently acquired European-based outfits to fortify their global standing, and it's working.
Last year, Office Depot generated $500 million in free cash flow. It also posted better-than-expected quarterly results last month. Despite a 3% dip in comparable sales, the June quarter ended strongly, trending towards positive comps for the first time in over a year. CEO Bruce Nelson expects his company to earn between $1.05 and $1.07 a share this year. That implies a forward P/E in the mid-teens
Also embracing the advantages of the delivery model, Office Depot clocked $2.1 billion in e-commerce sales. The platform is ideal for the company since most corporate customers are wired for Web access -- an even more cost-effective route than telephone-assisted orders.
Put it all together
The fact that the office-supplies sector is growing nicely might come as a surprise to some. With the lukewarm state of the economy, it might be easy to overlook the potential here. With companies laying people off and scaling back on corporate spending, you'd think Staples and Office Depot would have been hard hit. Staples remover? Out of Office Depot?
Not so fast. You might think that expansion abroad could be masking weakness at home, but it isn't. These are healthy, viable companies that are taking advantage of huge economies of scale while preserving margins through online sales and self-branded merchandise. Things can only get better for the superstore chains once the economy picks up and "Helped Wanted" signs start flashing again.
Do you buy Staples? Do you buy Office Depot? Don't take the decision personally. It is, after all, only business.
For more on the back-to-school shootout, see what the kids (and teachers) are saying over on our Staples and Office Depot discussion boards.
Rick Munarriz enjoys strolling the aisles of office-supply stores, red Swingline stapler in hand. However, he doesn't own shares in Staples or Office Depot. Rick's stock holdings can be viewed online, as can the Fool's disclosure policy.
