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Staples Q4 2012

March 08, 2013 | About:
The Science of Hitting

The Science of Hitting

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Staples (SPLS) reported fourth quarter and full-year 2012 results on Wednesday; for the full year, the company reported sales of $24.4 billion, down 1% from fiscal 2011 and down 3% after accounting for a 53rd week in the current fiscal year. The 10-K provides a nice breakdown by product category to show the annual change:

Category (% of Total) 2011 2012
Office Supplies 44.6% 43.9%
Services 5.7% 6.7%
Office Machines & Related 29.4% 29.7%
Computers & Related 15.2% 14.1%
Office Furniture 5.1% 5.6%


And then actual sales dollars (and year-over-year change), after adjusting 2012 to a 52-week period:

Category (% of Total) 2011 ($24.65B) 2012 ($23.9B)
Office Supplies $11B $10.5B (-4.5%)
Services $1.4B $1.6B (+14%)
Office Machines & Related $7.25B $7.1B (-2%)
Computers & Related $3.75B $3.35B (-10%)
Office Furniture $1.26B $1.34B (+6%)


The weakness in PC sales isn’t too shocking – Gartner estimates that global PC shipments were down 3.5% for 2012, with the U.S. declining at more than twice that rate (7.6%) according to IDC. In regards to PC sales for the fourth quarter, Demos Parneros, the president of North American Sales & Online, said the following on the call:

“Specifically with respect to PCs, PCs were under pressure in Q4. There was a lot of anticipation and build for Windows 8, as you mentioned, and that really slowed sales down, that in combination with people moving to tablets. And then the Windows 8 release, honestly, was below what we expected. One of the products was introduced. The pro model was introduced just recently to reasonably good reviews and decent sales but definitely below expectations. I would also say that touch product, which really makes Windows 8 a better experience, was scarce in the quarter. And also mobile phones, which integrate the tablet, the PC and phone experience together into really a new platform and a new ecosystem were also slow to be introduced. So we believe in Windows 8, we're excited about it. I like the recent things that we've seen. But it's got to build a little faster.”

Looking by segment, we can see that international continues to be a major headwind for Staples; here are the revenue results by segment over the past two years (using 53-week data in 2012 only because that level of granularity isn’t provided):

Segment 2011 Increase Over 2010 2012 Increase Over 2011
NA Stores & Online +1.7% +0.7%
NA Commercial +1.8% +1.7%
International +4.0% -10.2%


International will receive further discussion in my future posts; I would like to see the changes John Wilson, who used to be Staples CFO in the mid-1990s (recently brought back to the company as president of European Operations), can implement before I comment further.

Overall, retail sales were weak in Q4 – comps fell 5%, with the entire decline due to traffic; the company missed internal sales estimates, and this impact flowed through to the bottom line and caused SPLS to miss cash flow targets, as noted by CFO Christine Komola:

“Our free cash flow came in below our expectation of about $1 billion for the full year because as -- in early Q4, we built inventory in anticipation of stronger top line results. As sales came in below our expectations, we did pull back on inventory replenishments but we continued to pay down accounts payable. We pay our vendors a little bit faster than we turn our inventory, so this had a negative impact on working capital. Additionally, we came up short of our sales and earning goals for the year.”

For the full year, Staples’ comps declined 2% (with full-year sales for NAR & Online at $11.8 billion, and Staples.com sales up 3%), compared to a 2.2% decline for Office Max ($3.3 billion in annual sales from retail) and a 5% decline for Office Depot ($4.5 billion in annual sales from North American Retail); as those numbers show, the combined OMX/ODP (assuming 100% sales retention) would be about two-thirds as large as Staples North American Retail & Online business.

In North American Commercial, sales declined by 0.3% for the full year, and were flat after adjusting for the impact of Hurricane Sandy (pegged at 1% headwind in the fourth quarter); this decline was essentially by choice, as the company voluntarily walked away from two sizable contracts in late 2011 that didn’t provide adequate returns to the business (also known as “sound business practice”). Operating income was $680 million in the segment for 2012, up 3% from a year ago and 10 basis points as a percentage of sales (to 8.4%). This business continues to be overlooked by individuals stuck on insisting that Amazon will be the end of Staples.

Management’s fourth quarter commentary presented something that I haven’t quite seen before for the future of Staples; here’s a bit of what caught me in the company’s discussion on their strategic vision:

“While our ultimate goal is to increase sales and earnings growth, there are a number of other key metrics that we're planning to track and planning to share with you each quarter. We believe that these are important indicators of our progress and closely align with our vision.

First, we're highly focused on driving sales in categories beyond office supply. This year, we have plans to drive meaningful acceleration here. Second, one of our top priorities is to hyper-grow online. In 2013, we have plans to accelerate growth throughout the year and achieve high-single-digit growth in staples.com. Third, we'll continue to rapidly expand our assortments. Today, we have more than 100,000 SKUs on staples.com, and by the end of 2013, we plan to more than triple that number…

Our strategic reinvention is focused on accelerating sales and earnings growth, and we expect momentum on the top and bottom lines to build throughout 2013. To achieve this, we need to make a number of investments. This year, we're planning to reinvest the majority of our savings -- our expense savings in sharper prices, increased investment in IT, expanded brand marketing, customer acquisitions and talent and associates to better serve the need of our customers. We're also wrapping up the final phases of our European restructuring program. While the associated costs won't be large enough to exclude from our GAAP earnings per share, they will be a headwind on the bottom line early in the year.”

Consider that commentary from Mrs. Komola, as well as this from CEO Ron Sargent (it’s quite long, but I think it’s important):

Our reinvention plan includes 4 growth platforms: expanding our assortment beyond office supplies, accelerating growth online, redefining the Omni channel-experience and accelerating growth in our services business. I'm pleased to report that we're gaining momentum in each of these areas…

Our new vision is, 'Every product your business needs to succeed.' And we're confident that we can accelerate growth in categories beyond office products. A great example of this is our success selling facilities and breakroom supplies. During 2012, we had strong double-digit growth in North America and grew sales in this category by more than $200 million, ending the year with a $1.8 billion facilities and breakroom business.

We more than tripled our assortment on staples.com during the year, and we hit our goal of 100,000 SKUs offered by yearend. While we're still in the early innings of our assortment expansion, we see big opportunities in areas like technology products, medical supplies, safety supplies, mail and ship and office decor. We're also excited to report that we now offer Apple accessories on staples.com, and we'll have this assortment in our stores during the first quarter…

From an Omni-channel perspective, we're making it easier for customers to shop us wherever and whenever they want. On bringing our North American Retail stores and our dot-com businesses together, we're providing our customers with a more consistent shopping experience across the channels. During Q4, we combined our retail and dot-com merchandising and marketing teams and introduced new compensation plans which incent associates to drive sales, both in our stores and on our website. We recently launched our new features like Reserve Online and pick up in store, and we're seeing a very strong response from our customers. And we've also revamped and launched a new website in Canada with significantly improved features and capabilities. And during Q4, we developed a new 12,000-square-foot Omni-channel store with updated staples.com kiosk and an endless aisle shopping experience. We expect to open our first Omni-channel store in Q1 and we're confident that we can retain the vast majority of our sales in this new format while also driving sales of an expanded online offering.

I'm also pleased to report that just last week, we announced a new Staples rewards program in the United States that significantly improves our value perception with customers. This program is free to customers and offers 5% back in rewards on all products and all services. It also provides free shipping on all staples.com orders. We believe that the reinvention of our rewards program will make shopping at Staples even more compelling for customers…”

Let’s think about all of that – Staples is focusing on driving better pricing (their global leadership position in office supplies certainly helps), is number two in ecommerce behind Amazon (AMZN), offers free shipping on ALL orders (regardless of size and without the need for an annual membership of any kind), and offers next day delivery (as well as other options like in-store pick up, or likely in-store availability today on many products); I look at all that and think I know what management is setting their sights on – they want to become the Amazon for businesses, with an ability to service anybody from the small shop with a handful of employees that might need ink ASAP, or the large enterprise that needs a dedicated relationship via Staples Commercial division. Unlike the actual Amazon (which is focused on eBooks, tablets, AWS, etc.), Staples' management team is 100% focused on meeting the multi-channel needs of businesses (and cost isn’t always No. 1); I’ve never really thought about SPLS in this manner prior to the call (as being on the offensive), but think it might be where they’re focusing – and is a space where they have a good change of giving AMZN a fight.

Looking at guidance, management expects full-year sales to increase low single digits off of 2012 sales (52-week basis) of $23.9 billion. On the bottom line, management expects $1.30 to $1.35 in diluted EPS from continuing operations, suggesting 0-3% EPS growth for the year. Based on what was said during the call, this assumes no change from the OMX/ODP merger (“I think it's going to be good for our industry, but at this point I think it's just way too premature to say much more”), and also includes $150 million in expected cost savings in 2013 (largely from vendor negotiations), which instead of flowing through to the bottom line will be reinvested in the business; ironically, if that investment would have come in the form of capex (as opposed to being expensed), management would have easily cleared analyst estimates for fiscal year 2013 – which goes to show you just how irrelevant the headline numbers can be without further analysis.

The balance sheet is solid, with the current ratio over 1.4x and cash in excess of $1.3 billion. Management plans on completely repaying $867 million in January 2014 notes in the coming year, at which point the company will have just $1 billion in long term debt; considering that the company’s target credit rating can support debt-to-EBITDA north of 2x, this leaves the company with plenty of flexibility as we look beyond fiscal 2013.

In addition to paying down debt, the company continues with a strong buyback program – and repurchased about 5% of outstanding shares in 2012; including dividends, the company returned $743 million – or 8.6% of the current market cap – to shareholders for the year. In addition to the fourth quarter call, management announced a 9% increase in the dividend; with an annual payout of $0.48 per share, the current yield is just shy of 3.8%.

To be clear, international struggles are concerning, and North American retail still faces long-term headwinds (although starting to be run-off via downsizings and closures at lease expiration, with plenty of opportunity to continue doing so thru fiscal year 2015); with that said, Staples continues to offer a balanced approach to reinvestment in the business along with return to shareholders. With the OMX/ODP deal, the benefit of lower-rate debt, and continued improvement in the economy (and the commercial business), I’m content with sitting still and watching how the coming quarters unfold at Staples.

About the author:

The Science of Hitting
I'm a value investor, with a focus on patience; I look to buy great companies that are suffering from short term issues, and hope to load up when these opportunities present themselves. As this would suggest, I run a fairly concentrated portfolio by most standards, usually with 8-10 names; from the perspective of a businessman rather than a market participant / stock trader, I believe this is more than sufficient diversification.

I hope to own a collection of great businesses; to ever sell one, I would demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over many years.

Rating: 4.1/5 (28 votes)

Comments

batbeer2
Batbeer2 premium member - 1 year ago
>> Let’s think about all of that – Staples is focusing on driving better pricing (their global leadership position in office supplies certainly helps), is number two in ecommerce behind Amazon (AMZN), offers free shipping on ALL orders (regardless of size and without the need for an annual membership of any kind), and offers next day delivery (as well as other options like in-store pick up, or likely in-store available today on many products); I look at all that and think I know what management is setting their sights on – they want to become the Amazon for businesses, with an ability to service anybody from the small shop with a handful of employees that might need ink ASAP, or the large enterprise that needs a dedicated relationship via Staples Commercial division.

Yes!

For a most businesses out there, Staples is Amazon and UPS combined.

Thanks for the update.
Cornelius Chan
Cornelius Chan - 1 year ago
I always buy Staples branded paper because it is the cheapest in store.

It would be interesting to compare Staples/Amazon profit margin on ecommerce.

BEL-AIR
BEL-AIR - 1 year ago
Science of Hitting thank...


Spls is a stock that mr market has it wrong....

Like I said before I like it, my buy limit order was just short a while back, hope I can get it this time around.

Thank you for the follow up
waup7707
Waup7707 - 1 year ago
It appears that SPLS is fighting back with AMZN with on-line store expansion, free shipping, next day delivery etc. Let's assume that SPLS is successful in competing with AMZN in the next five years with similar level of customer satisfaction and pricing.

According to Valueline for the last ten years (2003-2012), average net profit margin is 2.1% for AMZN, and 4.2% for SPLS. Bezos is well known for his long-term thinking (ignoring short-term profit) and customer obsession. To hold off AMZN's relentless inroad, SPLS's margin probably needs to go down to AMZN's range. Then five years down the road, SPLS's margin may be cut in half (4.2% -> 2.1%). Even SPLS can grow top line 3%-5% per annum against ruthless on-line competitors, SPLS's EPS may well be below $1.00 in 2018. If the prospect of declining earning is high, the most critical question on investing in SPLS is what the proper P/E multiple on this name. At current price, my confidence level is not as high as you guys.
batbeer2
Batbeer2 premium member - 1 year ago
AMZN versus SPLS is no contest.

Amazon used to be a bookstore, now they also sell electronics. As a result, revenue has tripled while profits have been flat (at best!). If this were any other store, one would consider the outcome a predictable failure.

Seriously! If any bookstore reported that it had managed to triple its revenue by also selling some cameras but they weren't earning a dime more than they did when they were just selling books and DVDs, would you be impressed?

Last time I checked, SPLS was averaging operating income of $1B on $24B of revenue with share-count and debt in steep decline. The only metric Amazon is able to beat Staples on, is revenue (and share price).

Meanwhile, Staples has built a global distribution network. They have a presence in every major economy. Amazon doesn't even begin to have that. You can punch Amazon.com (or .co.uk) into your browser anywhere on the planet but you'll quickly find most items don't ship to where you're at. This is probably because a lot of the stuff Amazon has on its site is actually supplied by local vendors. These vendors have all sorts of reasons not to ship to say.... Holland or Australia.

From where I sit it looks like Amazon has lost the battle for global expansion. After 20 years, many countries now have their own Amazon copycats. Amazon is going to have a lot of problems dislodging them.

In contrast, everywhere you go, there is only one Staples.

Just some thoughts.

waup7707
Waup7707 - 1 year ago
SPLS may have superior global distribution system. However, based on 2011 revenue numbers, foreign sales is 43% for AMZN, and 21% for SPLS. From 2007 to 2012, Compound foreign sales of AMZN has grown ~35% per annum. With this kind of growth, I suspect AMZN has lost the battle of global expansion.
waup7707
Waup7707 - 1 year ago
When I analyze a business, I always heed this Ben Graham's quote,

"You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right."
batbeer2
Batbeer2 premium member - 1 year ago
>> However, based on 2011 revenue numbers, foreign sales is 43% for AMZN, and 21% for SPLS.

Yes. SPLS has yet to take a lot of market share abroad. It dominates the US already. SPLS in India today is a lot like SPLS in the US in 1988. It's the most efficient operator with lots of room to grow. Profitably.

Amazon is doing in Germany and UK what they already did in the US. Sell some electronics where they were first selling only books and DVDs. The result is likely to be the same too: no incremental profit.

hheffermehl
Hheffermehl - 1 year ago
I agree with most of your points, SoH, and like you I think SPLS is an excellent value here. I also happen to think an LBO of spls is still a possibilty (even if the deal buzz has died down). Size is often quoted as an unsurmountable obstacle in this regard, but that's nonsense imo, a club deal would get around the need for sizable equity. Consider a scenario in which the company is taken private at 16 USd with a 60-40 debt/equity structure, interest on the debt required below 7%, margins somewhat below the historical avg and very conservative growth assumptions. Do a quick and dirty calculation with these assumptions and you will find that the economics of an LBO are very, very favorable. I wouldn't be at all suprised to see SPLS taken private.
waup7707
Waup7707 - 1 year ago
$$$ Amazon is doing in Germany and UK what they already did in the US. Sell some electronics where they were first selling only books and DVDs. The result is likely to be the same too: no incremental profit.

By paying little attention to profit and serving customers extremely well
, AMZN is a formidable competitor in every segment it enters. Borders, Circuit City, Best Buy, RadioShack are retail victims steamrolled by AMZN's low margin practice. Who would be the next? shoe retailers (competing with Zappos.com)? office supply stores? pet supply stroes?

I think AMZN is far from a good investment at current price. But for any company competing with AMZN, it should never take AMZN's threat lightly.

hheffermehl
Hheffermehl - 1 year ago
Agreed, Waup. My view is that AMZN (and others) are indeed threats, but they are highly unlikely to put as much pressure on SPLS earnings as the current market price implies. Thats what my research shows, but opinions certainly differ on this point, and as the current market cap of SPLS also implies, I'm in the minority camp. Time will tell. Other victims of AMZN are out there for sure.I worry about PETS for example. As for AMZN as an investment, I wouldn't touch it with a ten foot pole at this point.
batbeer2
Batbeer2 premium member - 1 year ago
>> By paying little attention to profit and serving customers extremely well

So the business plan here is to put every other retailer out of business before finally earning some serious money.

1) I don't think it is going to happen in my lifetime.

2) Logic dictates Amazon takes on NILE and/or M next. That way, they can grow revenue while focussing on a relatively small number of transactions which they can execute magnificently.

Staples is the precise opposite of NILE. SPLS has lots of small (commodity) transactions. That is not where Amazon can grow easily without investing heavily in a better distribution network.

Just some thoughts.

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