Shares of Staples (NASDAQ:SPLS), the leading office-supply company in the United States, haven't performed well so far this year. After reaching $16 per share toward the end of last year, the stock has been repeatedly hammered by poor results from Staples' retail business, diving below $11 per share on multiple occasions.
Even though pessimism may be a popular stance to take at the moment, there are still a few valid reasons Staples' stock could rise in the long term, rewarding investors who stick around during the company's current troubles.
Store closings and downsizing
The retail store portion of Staples' business has fallen on tough times. Comparable-store sales are declining as demand for traditional office supplies wanes and customers increasingly make such purchases online. These trends have prompted Staples to announce that it will close 225 stores over the next couple of years, and along with the store closings that competitor Office Depot has announced, the number of office-supply superstores in the United States will fall dramatically.
Store closings may sound like a bad thing, but Staples' profitability has suffered recently from simply having too many stores. Here's a chart showing the operating income that Staples derived from its North American retail and online segment over the past couple of years.
Staples' retail business is heavily seasonal, but the trend is clear. What used to be a major source of profits for Staples is quickly turning into a liability, and the only way to reverse this trend is to reduce the store count. Some of the customers of closed stores will move to remaining stores, and profitability at the store level should improve as a result. Staples is also downsizing some stores to a smaller 12,000-square-foot format, and so far more than 95% of sales have been retained. Lower costs, combined with nearly all the sales of a larger store, lead to far better operating metrics.
While the short-term picture doesn't look great for Staples, once these store closings, and those of its competitor, are complete, profitability has the potential to rise significantly. And with the current P/E ratio in the low teens, rising earnings will probably lead to a rising stock price as well.
New categories driving commercial business
Besides retail, the other major component of Staples' business is North American commercial, which caters to businesses. The commercial segment has been far more resilient, growing while the retail segment has been shrinking, and this has been in part due to Staples' vast expansion of the scope of the products that it offers businesses. Going forward, continuing to expand its product assortment represents a growth opportunity that could drive the stock price higher.
One example of a success that Staples has had so far with this strategy is facilities and breakroom supplies. This is a complementary category to core office supplies, as businesses that need office products probably need cleaning supplies and the like as well, and Staples has grown this category into a $1 billion annual business that's still growing in the double digits.
New categories allow Staples to not only sell more to existing customers, but also pick up new commercial customers drawn in by the new products. This strategy has worked so far, as commercial has been a bright spot for the company, and if Staples can continue growing the segment, the stock price could follow suit.
An aggressive rewards program
Amazon.com (NASDAQ:AMZN) has been the bane of many retailers, with its consistently lower prices, free shipping above $35, and the $99 annual Amazon Prime membership that gives those willing to pay unlimited free two-day shipping. Staples has taken steps to remain relevant; it matches prices both in-store and online, and it uses its acquisition of tech start-up Runa to dynamically adjust its online prices to better compete. But Staples' rewards program, launched last year, may be its boldest step yet.
The base level of Staples' rewards, which is free to sign up for, offers free shipping on staples.com, with no minimum order size. While there's no guarantee of shipping times, expected delivery times listed for various items on the website were between one and four business days, with many items tending toward the lower end of that range. That speed makes it faster than Amazon's standard shipping that comes free with a $35 purchase, which typically takes at least five days.
While Staples' rewards shipping may not be as fast as Amazon Prime on average, it also doesn't cost anything, and members get a percentage back in rewards based on annual spending, as well as other perks. Staples' rewards program is probably aimed at small businesses that are too small to be serviced by the commercial segment, which targets businesses with 20 or more employees. For these customers, all of the benefits of Amazon Prime other than free shipping are largely irrelevant.
Staples' rewards gives small businesses an incentive to make all of their purchases at Staples, and the hope is that doing so will counteract the cost associated with no-strings-attached free shipping. In the long run, increasing customer loyalty, particularly among small-business customers, could greatly benefit Staples' top and bottom lines.
Staples is getting more efficient by closing and downsizing stores, it's adding new products to better fulfill the needs of its commercial customers, and it's offering an extremely aggressive rewards program in an attempt to increase customer loyalty. While the stock has suffered as of late, these three things have the potential to drive the stock price higher in the long term.
Timothy Green owns shares of Staples. The Motley Fool recommends Amazon.com and owns shares of Amazon.com and Staples. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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