When a company offers earnings guidance above analyst expectations, it's obviously a bullish sign, because, over time, earnings growth follows sales growth. And, when a company predicts greater sales or profits, we expect its stock price to soon follow.
Office supplies leader Staples (SPLS +0.00%) recently said that full-year earnings were expected to be slightly higher than last year, coming in the single digit range above the $1.37 it earned last year. This was a more promising outlook than what Wall Street was anticipating. Caught between economic malaise on two continents, it's been difficult to find many businesses anywhere wanting to buy more than a few reams of paper and some pencils. Despite the difficulties, however, the officer supplies purveyor has been able to tread water for the most part, largely because businesses do need paper, ink, and paper clips, and they're still able to generate more than $1 billion in free cash flow.
Now, don't go blindly buying on this somewhat more bullish sentiment, because you still need to do some research. Staples hasn't really changed its own outlook for the year -- analysts were just expecting less than management -- so use the announcement as a jumping off point for additional research.
A collapse of global proportions
Having bought European delivery service Corporate Express just before the collapse of the financial markets, Staples hasn't realized many of the synergies they thought they would from the acquisition. And, its International operations have been unable to gain any traction over fears the eurozone will unravel. Sales in its international markets plummeted 12% from the year ago period, as comps fell 6% due to a 4% drop in traffic and a 3% decline in average order size. Underscoring just how bad the recession is in Europe, Staples hasn't had a single quarter of same-store sales growth in more than four years.
But it really hasn't been much better here at home. Despite the occasional bounce, such as after President Obama's stimulus package wended its way through the economy, Staples' retail sales have pretty much been on a regular slide down. That's how it played out in the third quarter, with declines in computers and software more than offsetting the rise in copy and print services, leading to an overall 2% drop in sales.
A group buy
Yet, you can't pin the blame on Staples. This is an industry-wide malaise that's affected Office Depot (ODP +0.00%), which also suffers from anemic domestic sales and cratering European revenue s. OfficeMax (NYSE: OMX) has fared even worse, seeing more hope in the IPO of a building supplies company that it has a 20% stake in than in its office supplies business . While Staples may have some bloat in that it's so much larger than its rivals in store count, that heft has largely been responsible for allowing it to remain afloat and in a state of stasis.
But where Office Depot and Office Max have seen their shares more than double off the 52-week lows hit in September, Staples has risen a measly 11% in comparison. Of course, they moved up off much lower valuations.
An online destination
Like many other bricks and mortar operations, the advent of e-commerce has had an impact on Staples; but, with a sizable online presence of its own -- it's online business is second only to Amazon.com (AMZN 0.78%) -- it hasn't suffered nearly the same effects that Best Buy (BBY 2.44%) or Barnes & Noble (BKS +0.00%) have, enjoying some $11 billion in online sales.
But the sprawling physical presence that defined the retail landscape for many years looks like it's going to become a thing of the past. Online shopping is a trend that's only going to grow in size and importance, even for business supplies, and that means that Staples has to downsize, too. Through a combination of store closings, smaller format stores, and relocations, the office supplies leader will reduce its footprint in North America by 15% over the next three years .
Growth ahead
One innovation that should set Staples apart is the introduction of 3-D printing services through its partnership with Mcor Technologies. It will brand it as "Staples Easy 3D," and will start in early 2013 in Europe only. This portends to be a huge growth industry, as 3D Systems (DDD +0.82%) brings the price of 3-D printing below the $1,000 mark and within the reach of the average consumer, while Stratasys (SSYS 0.06%) targets the enterprise customer. By offering 3-D printing to customers, Staples is helping to accelerate the proliferation of the technology that just might add to its bottom line by differentiating the definition of "office supplies."
Unless and until the economy gains real traction -- and with the looming fiscal cliff that seems doubtful to happen -- it's difficult to recommend Staples as an investment for any immediate return. But at eight times earnings estimates, and an enterprise value at just eight times the free cash flow it generates, I think Staples is a discounted stock for the patient, long-term investor.
