There has been quite a buzz on the news about Staples Inc. (NASDAQ:SPLS) and their decision to close up 225 stores. We all wonder if this means. Is the company is on a downhill? Or is simply healthy reshaping?
Staples is certainly aiming to change its market strategy. They are closing 12 percent of its North American shops to shorten costs and focus on online sales. But they also announced that they would refresh about 20 percent of their products, adding new categories beyond office supplies. This comes as no surprise when we consider that the company’s biggest competitors are no longer OfficeMax (NYSE:OMX) and Office Depot (NASDAQ:ODP). Staples always had a scale advantage over these two. Bigger problems aroused with the growth of mass-market stores and online retailers. Buyers no longer need to go to actual physical shops, and if they do, they rather get everything they want from a single place. Firms such as Wal-Mart (NYSE:WMT) and Amazon.com (NASDAQ:AMZN) have lower cost structure and are likely to capture share in the office supply market.
Reliable company, difficult times
Staples has a solid history of good performances. It has regularly generated higher earnings than its peers and has routinely returned capital to shareholders via dividends and share buybacks. Members of its management have certainly been trustworthy, so why not believe Staples is still making the right choices? Closing up the stores will generate annualized pretax savings of about $500 million by 2015. Besides, online sales rose 10 percent in the fourth quarter, which would prove that restructuring towards online deals is the way to go.
But it might be too late for this changes to impact the foreseeable future. Increased competition from nontraditional office distributors, like Amazon and Wal-Mart, can depress Staples’s domestic margins. Online retailers benefit from a cheaper cost structure. Given Staples scale, its costs might still be a little lower than its emerging rivals, but as long as the difference remains small, it will be easy for the competition to earn share in the market by lowering the prices. If Staples matches other company’s prices to keep its share intact, it would depress its margins.
In addition, it’s important to consider that whereas Staples is a great operator, it has no solid economic moat. Its intangible assets –relationship with customers, office distribution- are likely to disappear once a competitor exceeds Staple’s cost advantage.
Staples is the world’s leading office product company. It has steadily grown by selling commodities, in a business that is vulnerable to recessions. So why should some fairly new competitors push the company to a downhill? In relation with OfficeMax and OfficeDepot, Staples has always benefited from a larger scale and better distribution. But this is no longer the case with online competition.
Except for the 10 percent increase of online sales, Staples has been reporting fairly disappointing operating profits. The revenue growth is now 1.80 percent, way below industry and history numbers. Chief Executive Ron Sergeant admitted the company was facing problems and announced he was willing to reinvent the firm. He claimed they aim to sell every product a business man might need. And that they will sell it as much online as in its retail stores. Staples will then be closer to Amazon’s kind of business, but with the advantage of having actual physical stores.
The question is, whether we can trust that they will do these changes on time, and be able to reduce costs to keep their share without sacrificing margins.
Disclosure: Damian Illia holds no position in any stocks mentioned.