Last Wednesday, Staples (SPLS) president & chief operating officer Mike Miles spoke to analysts at the UBS Global Consume Conference. I will lay out the quick case for why I think the valuation is attractive, but first want to supply some notes from the event as background:
Staples was founded in 1986 when its first location opened in Brighton, Massachusetts; a quarter of a century later, Staples is the world’s largest office products company (operating in 26 countries globally) with annual sales of roughly $25 billion (7% share of a $350B global market).
While most people think of Staples as a retailer, that’s actually not its largest operation; 60% of the company’s sales come from the delivery side of the business, which is comprised of contract (accounting for more than 50% of North American Delivery mix), catalog, dot-com (Staples.com, Quill.com, etc.), and the direct sales business, which collectively serve businesses of all sizes (the remaining 40% comes from retail). As an example of their breadth, the company serves more than 60% of the Fortune 100; at the same time, they have more than 200,000 mid-market customers in North America alone.
In this segment, the company is increasing share in the mid-market, which is where the profitable business is; in addition, they are continually expanding their Facilities & Breakroom supplies business ($800 million in sales and double-digit growth in 2011) with no signs of slowing down – they currently hold just a low-single digit share in the highly fragmented $23 billion market.
By geography, the company derives nearly 80% of its revenue from North America, with the remainder coming from international operations. At year end, the company had 1,583 stores in the U.S. and 334 in Canada; Office Depot (NASDAQ:ODP) exited Canada in mid-2011, leaving Staples alone in that market (out of the U.S. office superstores). Looking forward, the company continues to look for ways to optimize their real estate portfolio by reducing square footage (new store format is 15K square feet, compared to 24K) and successfully renegotiating leases (with more than 500 up for renewal in the coming 36 months).
The company’s international business ($5.3 billion in fiscal year 2011 sales) is struggling, with decent results in the European Contract business being mitigated by weakness in the European Retail business (2011 sales in the local currency were -2%, 0%, -7%, and -5% by quarter, respectively). The company has announced significant cost reductions to attack the general and administrative expense, which is the largest difference for the company between the profitability margins in North America and Internationally.
In retail, the company’s biggest initiative is Copy & Print. Using North America as an example, the company did $600 million at retail and $300 million in the contract print business in 2011, compared to a $50 billion market in North American copy and print; not only is this business growing, but the margins attained are extremely attractive at two times that of the overall retail business.
As promised, here’s my simplified view for the valuation: Over the last five years, the company has averaged more than $1 billion in FCF/annum, with nearly $1.2 billion in the most recent year and conservative 2012 guidance of simply exceeding the $1 billion threshold again. In the past couple of years, the company has spent roughly $400 million per year in capital expenditures (already subtracted in the calculation from FCF), which I’m going to say is 100% maintenance CapEx since I have no hard figures to go by that tell me otherwise.
With a market cap of $11.64 billion (as of the close Tuesday), the company’s FCF yield is more than ten percent, a figure that has mirrored the annual return to shareholders; for example, the 2011 dividend ($278 million) and share repurchase ($605 million) combined resulted in a payout of 75% of the company’s free cash flow generation for the year.
The actual cash return to shareholders (assuming the P/E is static at roughly 10x) is roughly 7.6% per annum at that ratio, and has the capacity to approach 10% annually with a tweak in capital allocation; again, just to be clear, this assumes that the company’s growth initiatives are unsuccessful, the international business (predominantly suffering from recession-hit Europe) doesn’t improve, and that the company doesn’t grab share from two weaker competitors (closing stores on a net basis domestically) in OMX and ODP.
For me, the choice is clear – Staples has a leading industry position, a good management team, and an attractive valuation; it's a steal on dips (like the big decline after the Q4 earnings announcement).
About the author:
I think Charlie Munger has the right idea: "Patience followed by pretty aggressive conduct."
I run a fairly concentrated portfolio, with a handful of positions accounting for the majority of the total. From the perspective of a businessman, I believe this is sufficient diversification.