Office suppliers have been one of the industries that have seen a lag in sales rebounding since the Great Recession hit. These companies are hit hardest by the loss of small business operations, as small business is the crux of their sales. As such, Office Depot (NYSE:ODP) has felt considerable sales declines since 2008, and has had to realign and cut costs. After significant cuts and now a merger with OfficeMax (NYSE:OMX), Office Depot finds itself in a much healthier position, yet finds it's share price considerably undervalued, and here is why.
With the merger, OfficeMax shareholders will receive 2.69 shares of Office Depot for every OfficeMax share. This will provide a total outstanding number of shares of ~519.3M for the now merged Office Depot Corporation. We may then recalculate the earnings per share for the entire corporation, shown in the final column of the table below (Dividing OMX's Earnings per Share by 2.69 and then add them to ODP's earnings per share).
Office Depot Earnings Per Share
OfficeMax Earnings Per Share
Recalculated OfficeMax Earnings Per Share
Merged Office Depot Earnings Per Share
It should be noted that the earnings for 2013 - 2016 are estimated earnings and are usually just an extrapolation, however it does give a good idea of where earnings hope to be in the future. Now taking today's share price of ~$3.60 for ODP, and using 2012's earnings per share, we see an overall PE ratio of 13.85. This is a fairly good PE ratio, particularly when one half of the company is reported a loss of $0.03 per share. Over the last several years, Office Depot has been cutting costs and streamlining operations to increase margins. Couple this with the cost savings of the merger, and Office Depot's margins should benefit nicely. With Office Depot's general and administrative expenses as high as 20% of their gross profit, a merger with OfficeMax may have substantial savings (or increased earnings) in the long run for the merged company.
Another metric I like to use to validate some of my more stronger investment opportunities is what I like to call, "What are the insiders doing?". As you can see from Office Depot records, there has been a slew of inside stock purchases in the last 6 months, with over $25M of shares being purchased, and as of yet, no sales. Sometimes a vote of confidence on a undervalued stock may be found in the amount of insider purchasers (and reversely sells for an overvalued stock). So when there is a large push of purchased stock from insiders, there is usually a good reason for that (or they would not be called insiders).
Lastly, it is well known that small businesses are a driving factor of sales growth in the US, with 54% of all US sales accounted for by the 23 million small businesses in America. More so, small business is the bulk of customer base of office suppliers (Quote - "Office Depot's customer base is a mix of small-business owners, people with home offices and everyday consumers..."). Sales at both office suppliers have dropped ~ 20 - 28% since 2008, a direct effect of the Great Recession. However, this reduction seems to have bottomed out with the latest YOY sales declines of only 2 - 4%. So as this economic fallout slowly mends itself (as is seen with the cyclical nature of economies, and the bottoming of YOY sales declines) throughout the next several years, there will be a significant boost in small businesses; ones that will be relying on companies such as Office Depot and Staples (NASDAQ:SPLS), providing for some significant increases in sales. So as Office Depot merges with OfficeMax, allowing the companies to further streamline operations, cut administration costs, and position themselves more competitively within their industry, a share price of ~ $3.60 seems like a very good deal right now.
Additional disclosure: I have positions in Office Depot and Staples and may even initiate another long position in Office Depot in the next 72 hours.