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The Science of Hitting
The Science of Hitting
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Retail Consolidation, Here We Come: Part 2

May 06, 2014 | About:

I wrote an article two months ago titled “SPLS & ODP: Retail Consolidation, Here We Come,” and have been patiently waiting for this day ever since. Just to rehash what that article was about (link if you’re interested), this section offers a sufficient summary:

“Here’s one final thing to consider from these figures: ODP and OMX have collectively closed about 75 stores per year since 2008 (and about 60 per year after adjusting for Grupo OfficeMax). Clearly, that hasn’t been enough – the impact of secular trends and a dominant primary competitor (plus increased competition from other retailers) means that the new combined company will need to look at making more aggressive moves going forward."

That brings us to some news from Staples: The company will close 225 stores by 2015 in North America – equal to a 12% decline from year-end 2013 levels. Now put this in the context of the information presented above and ask yourself one question: When Office Depot unveils its strategy for rationalizing its real estate footprint and consolidating stores in North America (which will be finalized in the second quarter and executed upon in the back half, per the fourth quarter call), how many stores will it close? Before you answer that question, consider the following: Three-quarters of its domestic leases – covering more than 1,400 locations - will expire over the next five years. In states like Texas and Florida, the combined company has more than 2x the number of retail locations that Staples has (getting to parity in those two states alone would result in the closure of 265 stores).

I’m looking for 125 to 150 closures per year from ODP through 2018 (five years), with some adjustment for downsizings from 20,000 to 25,000 boxes to 5,000 to 12,000 (on a side note, Staples now has 30 of its 12,000 square-foot locations; it is still retaining about 95% of their sales). If Office Depot does not come out with a plan that’s at least this aggressive, I’ll be very disappointed. If it do not choose to get serious about closing big boxes after a year like 2013, I’m not sure what it's waiting for.

This quote from Staples' CEO Ron Sargent captures my overall thought process on closures:

"I'm not sure we need as many stores today as maybe I thought we did five or ten years ago. Back then, I thought maybe 4,000 stores was probably the right number in North America. Today, in North America, my guess is there's probably room for 2,800 stores or 3,000 stores. And if you just carve out Canada, you're - probably in the US, there's probably room for, I don't know, 2,400 stores in the United States today."

I wouldn’t be surprised if the number of stores needed kept that pace (falling 50 to 100 per year) for the foreseeable future – meaning that there will be room for about 2,600 combined stores for SPLS and ODP five years from now. That would require closing about 1,100 stores by 2018.

Staples will take out 225 North American stores in the next two years, and I would bet will drop another 50 or so a year from there (on average); that leaves 725 stores to go from Office Depot – equal to 145 stores a year through 2018. Time will tell if this is accurate.”

Here’s the news for today, from the press release:

“The overlapping retail footprint resulting from the merger provides us with a unique opportunity to consolidate and optimize our store portfolio, while maintaining the retail presence necessary to serve our customers… Office Depot announced today that it has completed the preliminary analysis of the company’s U.S. retail store portfolio, and anticipates closing at least 400 stores by the end of 2016. The company expects to close approximately 150 stores in 2014, with the majority to be closed in the fourth quarter.”

Four hundred stores by the end of 2016 is pretty darn close to the 145 number I set as a benchmark; from my perspective, Office Depot’s management has made a sufficiently aggressive move. If this had not been the case, I would have serious concerns about my thesis going forward.

On the conference call, CEO Roland Smith added the following commentary:

“As I mentioned in my comments, we are completing our analysis as it relates to the store closures. We committed on our last call that we would complete that in the second quarter and we still plan to do that. We did want to today give you a preliminary look based on all the work we’ve done because we are comfortable with the numbers that we talked about today… At least 400 stores closing by the end of 2016, and 150 of those will be by the end of 2014.”

At this somewhat preliminary stage (the new CEO announcement was made less than six months ago), the management team has already seen enough to call for 400 or more closures by 2016. As noted in the slide deck, the ongoing real estate operations will include evaluating locations as leases near expiration or opportunistically; my take is that borderline closures – those likely to occur when lease expirations approach are not the focus of today’s announcement (they are captured in the “ongoing real estate operations” portion of slide eight). Said differently, I think further closures will be added to this total in the coming quarters; 400 may ultimately prove quite low.

Between Staples and ODP, we now have sight to at least 625 closures in the U.S. by the end of 2016 – enough to collectively reduce the U.S. retail store count for these two companies by nearly 20%. Considering this will happen in just 30 months, that’s nothing to scoff at.

This action alone gets us within spitting distance of Sargent’s 3,000 store target. If ODP and Staples collectively average another 50 closures per year in the off years (those not covered by current plans), that brings the total number of closures through the end of 2018 to about 900 stores. That’s equal to nearly one-quarter of the industry’s retail footprint in the region at year-end 2013.

Staples will report its quarterly results in two weeks, at which point I’ll provide my thoughts on the results for both companies. While the structural industry challenges remain, per-store economics are likely to see a noticeable improvement in the coming years as a result of these actions; the Max-Depot merger is accelerating the rationalization we’ve been waiting for.

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.

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