Staples Is Not A Retail Value Bargain Yet

Feb.21.14 | About: Staples, Inc. (SPLS)

This specialty realtor looked like a good candidate for the bargain bin recently sliding back down to $13 per share. Staples (NASDAQ:SPLS) boasts a heft dividend of 3.7% and continues to return capital through buybacks. Cash flow has been steady over recent years with free cash flow recently coming in at $900 million per year.

The company is facing a number of growth challenges with online and low cost competitors challenging a brand built on bricks and mortar. SPLS has responded with a vastly improved online experience and enhancing its commercial services.

Valuation

In analyzing SPLS we applied an FCF approach to arrive at a fair value price. First, SPLS has exhibited a higher than average beta and after accounting for the equity risk premium estimate an required equity return of 9.7%. SPLS was able to issue debt recently at 4.75% and we would note the substantial benefit of debt financing vis a vi equity on an after tax basis. SPLS capital structure is heavily equity weighted at nearly 80%. We estimated free cash flow of $900 million after allowing for $350mm of ongoing capital investments.

Given SPLS recent challenges we've estimated its long run growth rate of zero, which we expect to be negative in the short term. Plugging in these values we arrive at a fair value price of $13.21 indicating the shares are priced fairly.

Given the disparity of debt and equity financing costs we would revisit SPLS should they leverage their balance sheet and buyback stock. If a substantial leveraging can occur without increasing an above average beta the strategy should provide a substantial boost to shareholders.

We recommend investors hold current shares in SPLS and look for signs of stabilizing revenue which could provide just the window for increasing the tapping the debt market and buying back stock.

SPLS Chart

SPLS data by YCharts

Free Cash Flow Model  
WACC  
Equity Cost  
Risk Free Rate (10yrTsy) 2.75%
Equity Risk Premium 5.17%
Beta 1.35
Equity Cost of Capital 9.7%
Debt Cost  
Market Cost of Debt (2023 Notes) 4.75%
Tax Rate 35.0%
Cost of Debt 3.1%
Debt to Equity  
Shares Outstanding 654,051
Share Price 13.01
Equity Market Capitalization 8,509,204
Faiir Value of Debt (10Q) 1,970,325
Debt to Total Capital 18.8%
WACC 8.5%
Free Cash Flow  
FY2013 Net Income (210,825.00)
Depreciation 1,298,309.00
Interest 162,477.00
Less: Reinvestment (350,000.00)
Free Cash Flow 899,961.00
Growth Rate 0.0%
Multiplier 11.79
Enterprise Value 10,611,879.17
Less Debt Value (1,970,325)
Estimated Equity Value 8,641,554.17
Target Price 13.21
Click to enlarge

Disclosure: I am long SPLS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.