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The Science of Hitting
The Science of Hitting
Articles (454) 

Staples - Significant Savings Ahead

January 17, 2013 | About:

I’m going to keep this article relatively brief, because the office supply retailers (the line of business they are most well-known for, anyways) will be reporting earnings in the coming weeks, which should leave us with plenty to discuss. However, Staples (NASDAQ:SPLS) recently made a few moves well worth discussing before that time rolls around.

Let’s start by taking a look at the company’s 10-K for the year ending Jan. 28, 2012 (fiscal year 2011); in that year, we see $173.8 million in interest expense, broken down (roughly) as follows:

Debt Rate Expense
$325M of October 2012 Notes 7.375% $24M
$1.5 B of January 2014 Notes 9.75% $146M

The October 2012 notes were paid off in full upon maturity, in addition to $500 million of 7.75% notes that matured in April 2011 (no additional notes issued on either occasion); as such, the interest expense year to date (through the end of October 2012) has decreased slightly:

Interest Expense Through Q3 Full Year
FY 2011 $131.1M $173.8M
FY2012 $124.2M $161M (Estimate)

Where this starts to get interesting is when we look at recent activity. In the past week, Staples has made two material announcements: The first is early redemption on half ($1.5 billion) of the January 2014 notes; the second is new issuance of $1 billion (collectively) in 5 and10 year notes (split evenly between the two issues), at a rate of 2.75% and 4.375%, respectively. Modeling this for fiscal year 2013 and fiscal year 2014 (as compared to fiscal year 2012) shows why this matters to SPLS investors:

FY 2013 Interest Expense Annual Expense FY2013 Savings
$325M of October 2012 Notes 7.375% + $18M (9 Months)
$750M of January 2014 Notes 9.75% + $73M
$500M of January 2018 Notes 2.75% - $13.75M
$500M of January 2023 Notes 4.375% - $21.875M
TOTAL + $55.4M

That brings our fiscal year 2013 interest expense to about $100 million, down significantly from fiscal year 2012; here’s our data for fiscal 2014 (again, comparable to our expected figures for fiscal 2012):

FY 2013 Interest Expense Annual Expense FY2013 Savings
$325M of October 2012 Notes 7.375% + $18M (9 Months)
$1.5B of January 2014 Notes 9.75% + $146M
$500M of January 2018 Notes 2.75% - $13.75M
$500M of January 2023 Notes 4.375% - $21.875M
TOTAL + $128.4M

By my back of the envelope calculations, fiscal year 2014 interest expense should be around $35 million to $40 million – about $120 million to $125 million less than what will be paid in fiscal 2012 (this is oversimplified due to the impact of the company’s revolving credit facility and various other lines of credit, but the numbers are approximately correct). Assuming that the net number for Staples results in an additional $100 million flowing through to the bottom of the P&L (to adjust for tax savings, interest expenses related to credit lines, etc), the result will be material to the company’s reported earnings; with 667 million shares outstanding as of the most recently quarterly report, these savings could reasonably be expected to increase full year earnings per share by $0.15 – on FY2011 results, that would be a boost of more than 10%.

It looks like the market appreciated this move, with shares jumping 9% over the past five days (compared to slightly higher – a half a percent or so – for the S&P 500). With industry store closures and downsizings starting to ramp up (and expected to continue for the next 36 months), I continue to believe that SPLS will be the ultimate beneficiary of consolidation in office supply retailing.

About the author:

The Science of Hitting
I'm a value investor with a long-term focus. As it relates to portfolio construction, my goal is to make a small number of meaningful decisions a year. In the words of Charlie Munger, my preferred approach to investing is "patience followed by pretty aggressive conduct". I run a concentrated portfolio, with a handful of equities accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

Rating: 4.7/5 (14 votes)


Sdwolff - 4 years ago    Report SPAM
Dear Science,

As always, I appreciate your thoughts on SPLS.

I, too, like the stock from a value standpoint (it comprises ~8% of my portfolio).

The problem I have is that in order for SPLS to have better earnings, they need to close less profitable stores, sell of their European business, pay off their debt, and buy back shares.

While I believe these strategies will push the share price up, there isn't a catalyst for revenue growth. Furthermore, there's the nagging fear that sometime in the future AMZN and WMT could eat their lunch - event though they haven't yet.

In contrast, the story with MSFT is better. They have a larger competitive moat. And, while it's true that someday google could erode that moat, there is also the possibility for organic growth through Search, Phones, Tablets, etc.

If I couldn't sell for 10 years, I'd be much more happy holding MSFT than SPLS, which is why it comprises a larger precentage of my portfolio.

Given the fact that you hold more MSFT than SPLS, I bet you feel this way too.

It would be interesting to hear your bearish thoughts on SPLS, and what limit you would place on accumulating it in your portfolio....

The Science of Hitting
The Science of Hitting - 4 years ago    Report SPAM

Interesting comment - one I agree with almost 100% (across the portfolios I manage personally, I have much larger stake in MSFT than SPLS, for many of the reasons you mention). I would suggest you read all of my previous articles about SPLS (and the comments), many of which cover the many concerns of investors looking at or currently invested in SPLS; any specific questions beyond that I would be more than happy to discuss with you. Thanks for the comment!
Swnyc2 - 4 years ago    Report SPAM

I noticed in an earlier post that you had similar large-sized stakes in MSFT and JCP. I also recall in another post your lamenting that you had already bought so much SPLS that you were uncomfortable buying more, because you didn't want an even more concentrated SPLS position in your portfolio.

My question is this: aren't you at risk for having purchased too much JCP?

For example, my stake in JCP is much smaller than my stake in some other stocks such as MSFT because I view JCP as a much more volatile stock. Its price not infrequently can move 5% in one day. If JCP were to drop to $15 per share in the near future, I would not be shocked (it was 15.69 a few months ago). I would also strongly consider adding to my position in that event. However, if my stake in JCP were already 15% of my portfolio, I would hold back, not wanting to take to an even bigger risk in this one stock.

I am all for having a concentrated portfolio of my best ideas. I believe that can lead to better returns (and less work) than investing in a larger number of stocks. Do you have any thoughts on how big a position to take in an individual stock? My thought is that whenever you take a position in a stock, you should always be willing to meaningfully add to your position if the stock substantially decreases in price AND the reasons for owning the stock have not changed. For example, if a stock goes down by 30% after purchasing it, and one is not willing to buy more, despite the fact that the reasons for owning it haven't changed - then one probably owns too much of the stock.

In your case, if JCP were to do down to $15/share, would you substantially increase your stake?

The Science of Hitting
The Science of Hitting - 4 years ago    Report SPAM

That's a really good question; let me go at this one point at a time.

You're correct about SPLS - I wasn't able to add it once the market cap got to about $7B; I think 7x sustainable FCF (14.3% FCF yield) is a more appropriate buy price for this type of investment (potential for slow/no growth is real, as you noted) if you require a sizable margin of safety - in fewer words, I think I might have been a bit too aggressive when SPLS was at a level of 10x or so.

In terms of JCP, you make a valid point; obviously I don't know if it's going back to $15 or not, but there's no question about the volatility. There's one big reason why I'm not too concerned about this position - a reason that might not apply to everybody else: I'm quite young, with limited savings, and I plan on being a net saver for another 30-40 years.

At the rate I'm currently going, my total savings (amount invested in equities) increases about 3% or so every month - meaning that my AUM will have increased about 40% by year end. My point is this - I'll be putting more capital to work with time, and it will likely cause my current savings to look insignificant a few years down the road. I'm committed to an investment in JCP at least through 2015, meaning that my current portfolio ("X") will have more than doubled in size simply via new savings (even assuming no capital appreciation or dividends) over the next 36 months; that 15% stake in JCP will be closer to 6-7% at that time assuming no additional purchases over that time period. I'm not sure I want it to be 20-25% of my portfolio when I have a bit more than I do today (say 2015) - but I'm fine with it being 10%, which is what I'm right in-line for assuming 1-2x decent purchases of JCP common along the way; I think $15 will be a pipe dream within a few quarters, so I'm inclined to make those purchases if I can (thankfully Mr. Market can't see past next month and has been quite manic depressive with this company).

In terms of concentration, I'm not much for setting arbitrary constraints on position sizing. Obviously that doesn't mean I would make SPLS 100% of my portfolio just because I think it's cheap - but I also would have no qualms about adding to Berkshire (which is about 25% of my portfolio) if it fell 30% without any change in the fundamentals; that holds true for any business I own where material value creation per share is all but assured over time (in my view, PEP and JNJ both meet this requirement).

To answer you're last question, I only need one word: absolutely.

Thanks for comments! Look forward to your response!

The Science of Hitting
The Science of Hitting - 4 years ago    Report SPAM

Actual number for 2012 interest expense: $162.4 million - for correction, I was off by $1.4 million.

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