Staples and Office Depot downgraded by Bernstein Research

(Note: our blog occasionally reports articles about Staples and Office Depot because both companies operate "copy/print centers").....

Bernstein downgrades Staples, Office Depot

Wed Jul 11, 2012 9:00pm IST

(Reuters) - Bernstein Research downgraded office supplies chains Staples Inc (SPLS.O) and Office Depot Inc (ODP.N) to "market-perform" from "outperform," citing stalling employment trends in the United States and a broadening recession in Europe.

The research firm expects Staples' full-year revenue to decline and said that its cost-cutting initiatives will not significantly add to its earnings.

Growing competition from online retailer Amazon Inc (AMZN.O) could also hurt profits, Bernstein analyst Colin McGranahan said in a note to clients.

"Current cost efforts (of Staples) look to be more surgical than transformative, and we do not expect much margin benefit in a sluggish topline environment," McGranahan said.

For Office Depot, he expects benefits from the company's margin-boosting initiatives to moderate over the rest of the year.

The company's plan to increase retail store footprint by converting bigger stores to several smaller ones will also not significantly add to margins, the firm said.

The stock has nearly halved in value over the past year, indicating investor pessimism. The analyst too said the cyclical business had few growth catalysts for the next several quarters.

Data released last week showed that U.S. employers hired at a dismal pace in June, with non-farm payrolls growing by just 80,000 jobs in June.

McGranahan lowered his price target on Staples to $14.00 from $18.00, and that on Office Depot to $2.50 from $6.00.

Staples shares were down 2 percent at $12.66 on the Nasdaq, while those of Office Depot were down 5 percent at $2.06 on the New York Stock Exchange on Wednesday.

(Reporting By Krithika Krishnamurthy; Editing by Sreejiraj Eluvangal)

Comparing STAPLES and AMERICAN REPROGRAPHICS CO (ARC)

I thought it would be an interesting exercise to compare “the numbers” of two public companies who are both considered companies who operate in the “business services” market sector (from a market/industry “classification” perspective, is what I’m referring to.)

First one up; STAPLES, my very favorite “office supply” enterprise. I think (but am not 100% positive) that Staples is the largest office supply company in the U.S. (and in the world.)

Second one up; AMERICAN REPROGRAPHICS CO (ARC), the largest reprographics company in the U.S. (and in the world.)

Staples’ numbers and ARC’s numbers “courtesy” of “Google Finance”

	STAPLES	52 wks ended	52 wks ended	52 wks ended	52 wks ended
		1/29/11	1/30/10	1/31/09	2/2/08
	Total Revenue	$24,545	$24,275	$23,084	$19,373
	Cost of Revenue, Total	$17,939	$17,802	$16,837	$13,822
	Gross Profit	$6,606	$6,474	$6,247	$5,551
	Operating Income	$1,574	$1,382	$1,372	$1,548
	Interest Income(Expense), Net Non-Operating	-	-	-	-
	Income Before Tax	$1,357	$1,156	$1,243	$1,554
	ARC	Year-end	Year-ended	Year-ended	Year-ended
		12/31/10	12/31/09	12/31/08	12/31/07
	Total Revenue	$442	$502	$701	$688
	Cost of Revenue, Total	$299	$323	$416	$401
	Gross Profit	$142	$178	$285	$287
	Operating Income	$(18)	$14	$83	$136
	Interest Income(Expense), Net Non-Operating	$(24)	$(26)	$(26)	$(24)
	Income Before Tax	$(42)	$(12)	$58	$111
	Comparisons:	% to Sales	% to Sales	% to Sales	% to Sales
	Gross Margin:
	Staples	26.9%	26.7%	27.1%	28.7%
	ARC	32.2%	35.5%	40.7%	41.7%
	Operating Income:
	Staples	6.4%	5.7%	5.9%	8.0%
	ARC	-4.0%	2.7%	11.9%	19.7%
	Pre-Tax Income:
	Staples	5.5%	4.8%	5.4%	8.0%
	ARC	-9.5%	-2.4%	8.3%	16.2%

	Comparisons:	share price	share price	share price
		3/31/10	3/6/09	12/1/07
	Staples	$19.42	$14.81	$23.65
	ARC	$10.35	$2.86	$15.91

Many years ago, when it was early in my career in the reprographics business, one of the local “independent”, single-store “office supply” companies, right on our block, was rumored to be for sale. That particular company, Moffitt Office Supplies, had been in business for at least 30 years, by that point in time. I remember (at least somewhat) weighing the “pro’s and con’s” of being in the office supply business and how that business differed from the reprographics business we were already in. If the reprographics business, at least back then, lacked ‘sexiness” and ‘pizazz’, well, what about an office supply company? Boring. Boring. Boring. No technology. Inventory intensive. Lots of space required for inventory storage. Anyway, the office supply company that was rumored to be for sale did actually get sold. But, it closed just a few years later. The new owners weren’t able to do much with it.

Staples took the office supply business not just to a new level, but to a different stratosphere. In the office supply business, as Staples has clearly shown, “size” (scale) matters”. Because of its size, Staples benefits from economies of scale that other smaller office supply companies don’t have. But, even the Staples of today is, I think, kind of a boring business.

But, “boring can be safe”. And, “boring” can prove to be very profitable, as Staples has shown. So, when you get right down to it, would you rather be “boring” and safe and profitable, or would you rather be “exciting” and less safe and less profitable.

Although ARC and Staples have primarily grown by different methods; ARC mostly by acquisition-growth and Staples mostly by organic-growth, both Staples and ARC have amassed significant “scale” within their respective industries.

As you can see in the financial results tables, ARC and Staples have fared quite differently, 2007 – 2010. From 2007 to 2010, Staples grew. During that same time frame, ARC went downhill. When ARC was busy and bustling with robust sales activity, ARC’s gross margin was much greater than Staple’s. But, as ARC’s sales declined, the difference between ARC’s gross margin and Staples’ gross margin narrowed, quite a bit I might add. Also note that, on a pound for pound basis (operating profit, %age to %age), ARC was much more profitable than Staples, but as ARC’s sales plummeted, ARC’s operating profit percentage went down under Staples’ operating profit, and, in fact, by 2010, vanished (turned into a loss.)

I’m of the opinion that ARC’s business is much sexier than Staple’s business. ARC is involved in “technology”. Staples may be somewhat involved in technology, but certainly not as involved (pound for pound) as ARC is. And, I think it’s just that – sexiness and pizazz – that gets investors excited about ARC’s stock. Note RW Baird & Co’s recent upgrade of ARC to “outperform.”

On March 31, 2011, Staples was trading at a P/E multiple of 16.05x trailing twelve month earnings (of $1.21).

ARC lost money last year, so its P/E multiple can’t be computed. But, had ARC earned $.05 per share last year (2010), ARC’s P/E multiple (twelve month trailing basis, if we gave ARC $.05 per share) would have been, on March 31, 2011, a whopping 207.0x trailing twelve month earnings!

I just checked the “analyst estimates” of EPS for both companies for 2011.

The “mean” estimate for Staples is $1.54 EPS for 2011.

The “mean” estimate for ARC is $.13 EPS for 2011.

So, based on “forward twelve month earnings” and on the price per share that both companies were trading at on March 31, 2011:

- - - Staples was trading at a P/E ratio of 12.6x times estimated forward twelve month earnings.

- - - ARC was trading at a P/E ratio of 79.6x estimated forward twelve month earnings.

Maybe Staples should purchase ARC. Perhaps that would generate some P/E multiple pizazz for Staple’s stock. I’m positive that the shareholders of Staples would be very pleased to see Staples’ stock trading at 40x estimated forward earnings! That would generate stock price of $48.00 per share!