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Does Staples Have a RadioShack Problem?

By Alex Dumortier, CFA – Mar 6, 2014 at 8:35PM

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Staples faces the same challenges as RadioShack, but it has a few advantages.

With the number of people filing jobless claims last week dropping to a three-month low, the market may be heading into tomorrow's release of the February employment report with a measure of optimism. The benchmark S&P 500 index rose 0.2% to a new record high, while the narrower Dow Jones Industrial Average (^DJI 0.41%) gained 0.4%. Retail companies are in the news today, as Staples (SPLS) reported fiscal fourth-quarter results that disappointed, sending the shares down 15%. Meanwhile, RadioShack (RSHCQ), which suffered its own 17% drop on Tuesday, lost another 6% on the back of an analyst downgrade.

It's hardly surprising that Staples' earnings report got a chilly reception from the market, with the company missing Wall Street's expectations on adjusted earnings per share (for the third time in the past five quarters) and revenue (for a five-quarter streak). Guidance for the current quarter also fell short of analysts' expectations.

CEO Ronald Sargent outlined the company's predicament during a call with investors and analysts when he observed that "our customers are using less office supplies, they're shopping less often in our stores and more online, and their focus on value has made the marketplace even more competitive." The company is responding, however, with the announcement that it will close up to 225 stores in the U.S. and Canada – 12% of its North American store base (too little, too late, some would argue.)

All is not lost yet for Staples, which has a couple of advantages:

  • Staples is already an e-tailer, generating nearly half of its sales online. Online sales grew 10% in the fourth quarter.
  • It is the largest pure-play operator in the segment of office supplies. If you don't think scale matters, just compare the cash profitability and returns of Staples with those of the number two firm, Office Depot.

Nevertheless, those advantages do not silence every threat, and the company remains in a challenging position. As it increasingly becomes an online retailer, how will it differentiate itself effectively and durably from e-commerce champion In online retail, the main competitive factors are price, selection, and ease-of-experience; Amazon is very tough to beat across all three. As Staples notes in the Risk Factors section of its 10-K report:

We operate in a highly competitive market and we may not be able to continue to compete successfully... Some of our current and potential competitors are larger than we are, may have more experience in selling certain products or delivering services or may have substantially greater financial resources.

One way Staples can differentiate itself is through its Staples-branded products, which represented 28% of its sales in 2013; but one has to wonder how wide a moat this might constitute.

Staples' earnings announcement is reminiscent of that produced by RadioShack on Tuesday (in nature, although not in severity), in which the electronics retailer announced a huge earnings miss and plans to close 1,100 stores. Unlike Staples, however, RadioShack is not the number one pure-play retailer in its sector (that title belongs to Best Buy.) On Tuesday morning, I concluded:

In two years' time, do you think e-commerce will represent a smaller or larger proportion of retail in general, and electronics items specifically? It would not surprise me if RadioShack had filed for bankruptcy long before then.

Even after Tuesday's 17% drop, there is plenty of potential downside left for RadioShack speculators... err, investors. Today provided evidence of that, with the stock falling another 6%, as Goldman Sachs slashed its price target for the shares to $1 from $2.25, citing an increased probability of default:

The cut primarily reflects the higher probability assigned to default within three years by the CDS market, now about 80% vs. 56% in October. The probability assigned to our $5 turnaround scenario is now 20%.

Retail is a brutal business undergoing massive change -- it's not an industry that is favorable to identifying low-risk, long-term investments. As far as betting on the disrupters goes, that presents a set of challenges all its own.

Alex Dumortier, CFA has no position in any stocks mentioned. The Motley Fool owns shares of Staples. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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