For a stock that is rated a 'hold' by analysts, Staples (SPLS) has certainly had a lot of buyer interest this year. Its stock is up by 14.9% in the year-to-date, which compares favorably to the 9.6% return of the S&P 500 in that span. Its return is also superior to that of the retail sector, as represented by the S&P Retail Depositary Receipts (XRT), which has risen by 13.5% in the year thus far. Retail sales are showing signs of bottoming-out and some investors are bidding-up retail stocks in the hopes of catching a sector on the rise.
When Staples reports on May 22nd, analysts expect it to report fiscal first quarter earnings of 27-cents per share - 10% lower than the 30-cents it earned in the same period a year earlier. That would put it on a path to earning $1.33 per share this fiscal year - around 6-cents short of its mark in the past year. Judging from its earnings history, Staples could beat the consensus, as it has in the last two quarters, but still register further consolidation in earnings growth as it saw its top line decelerate in three of the past four quarters and earnings growth contract each quarter over the past four.
It should also be noted that while Staples has registered strong stock performance this year, on a relative basis, it is trailing its two closest rivals, OfficeMax (OMX) and Office Depot (ODP), whose shares are up 19.6% and 17.1%, respectively, in the year thus far.
To make things more interesting for Staples, these two firms are planning to merge to form an entity with an excess of $17 billion in annual revenue, which would bring the new conglomerate within $7 billion of Staples' annual sales figures. That might appear to be a comfortable gap but, assuming the combined entity's revenues grow at the forecasted pace of its forebears, it could exceed Staples as the United States' largest office supplies retailer as early as 2015. Whether the deal actually pushes through is the billion dollar question: Staples itself attempted to acquire Office Depot in 1997 but was rebuffed by the Federal Trade Commission on competitive grounds.
Staples' shares recently fell below their 200-day moving average of $12.30 but have recovered somewhat to $12.40. With the current trajectory of its trend-line, Staples could see further consolidation below this range - the question is: should investors be paying attention?
What We're Looking At:
Revenue Growth. Staples' earnings are expected to contract 1.8% this year and 0.3% the following year. However, they're expected to recover beyond that, with the office supplies giant registering 6.6% EPS growth, on average over the next five years (including the second down year). While this is just over half of the 12.7% forecasted growth rate of its industry in the same period, it nevertheless represents an acceleration of its own profitability - in fact, 6.6% would be more than double the 2.8% growth rate of its earnings for the prior five years.
Moreover, earnings in its industry are expected to slow. The 12.7% growth rate that is so impressive compared to Staples' is actually a steep dip from the 15% and 20% EPS growth rates it's forecasted to post this year and the next. That implies an average growth rate of just 10.7% from 2016 to 2019 - not egregiously higher than Staples average expected growth rate of 6.7% for the same period.
In short, Staples' earnings are forecasted to accelerate during a period when its industry's are set to slow down. That is impressive considering that Staples is the largest entity in the space. To put that in perspective, a 6.7% earnings growth rate for Staples implies an 86% earnings growth rate for OfficeMax and 298% growth for Office Depot.
It should also be noted that analysts' earnings forecasts don't yet consider the impact of cost-cutting and cost-saving measures that it is implementing across its North American and European operations. Successfully implemented, these could boost EPS by as much as 20%, further narrowing the perceived gap between its earnings growth and that of its industry.
Eschewing these headline numbers also allows potential investors to focus on one important thing: Staples's dividend yield. At 3.7%, its yield is 76% higher than the S&P 500's and is positively stratospheric compared to OfficeMax's 0.7% yield. What's more, Office Depot doesn't even register on this basis since it has no dividend to speak of. Its dividend actually has an equalizing effect between Staples and its rivals - its 3.7% dividend essentially raises its total return to 18.6%, which is not far from OfficeMax's 20.3% total return and nearly 10% better than Office Depot's 17.1%.
Valuation. Staples is currently trading at a forward Price-Earnings (P/E) ratio of 8.8x - that is a significant discount (38%) to the S&P 500's forward P/E ratio of 14.1x. It is also lower than Office Depot's 32x forward P/E and OfficeMax's 13.2x.
Other measures paint a similar picture: its price-to-sales ratio is at just 0.36x - compared to its industry's 0.5x while its price-to-book value is at 1.42x - a 44% discount to its industry's average. Staples is also trading at a discount in terms of its cash flow at 15x compared to 34x for its industry.
Given these measures and its relatively middling gains for the year, it is fair to conclude that Staples is somewhat undervalued, especially considering that its two largest peers have registered higher gains even though their own valuation ratios are either worse off or only modestly better than Staples.
In conclusion, the recent price action in Staples is an opportunity to buy the stock. While its headline numbers are certainly not eye-catching, it is still the best play in the Office Products space, especially considering the volatility of its two peers: OfficeMax has a beta of 2.1 while Office Depot's is 3.03. Staples', on the other hand, is a far steadier 1.46. In effect, you're getting 91% of the return of Office Max with 31% less volatility.
For the balance of the year, Staples will easily add another 10 to 15% in returns, which could translate into a return of as much as 20% to 25% for investors who pick up the stock during the expected summer pullback.
Additional disclosure: Black Coral Research is not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.