In this article I'll have a closer look at Staples (NASDAQ:SPLS) which fell by a double-digit percentage last week when it announced its financial results for 2013. I will provide my view on the financial results and the company's balance sheet where after I will provide an outlook for 2014. This will result in my investment thesis at the end of this article.
All images in this article were sourced from the company's press release.
My view on the financial results
Staples reported a total revenue of $23.1B in 2013, which is a 5.3% decrease compared to 2012. Fortunately the company was also able to keep its cost under control which resulted in a 7% lower gross profit. The operating income, however, doubled to $1.1B but this is easy to explain as there were no impairment charges in 2013 and the restructuring charges were much lower than in the year before. Staples' financial results were also clearly influenced by a lower interest expense which dropped by more than $40M to $119M for the entire year 2013. All this resulted in a net profit of $620M or $0.95/share.
As most of my readers know, I also always like to have a look at the cash flow statements of a company, as I believe those statements usually offer a better indication of the quality of the underlying business. When looking at the cash flow statements, Staples reported an operating cash flow of $1.34B before changes in working capital and as the company spent just $405M in capital expenditures (excluding the non-recurring costs of acquiring new businesses), Staples actually had a free cash flow of $935M. The majority of the free cash flow went back to the shareholders' pockets as Staples used $312M to pay its dividend and $340M to repurchase its own shares for cancellation. As such, over $650M was directly or indirectly returned to its shareholders, and the balance was used to reduce its debt profile which will enhance the free cash flow even more, further down the road.
My view on the balance sheet
When moving over to the balance sheet, one can immediately see that Staples' balance sheet looks very healthy. The working capital position as of February 1st 2014 was an interesting $1.87B and the current ratio was 1.55. As the ratio is higher than one, it means the company has sufficient current assets to cover its current liabilities and I'm not expecting any near-term financing or liquidity problems for Staples.
As of at February 1st, the book value of Staples was roughly $9.39/share or $3.84/share if you'd exclude the goodwill and intangible assets of the company.
Outlook for 2014
Staples has released an official guidance stating it expected the revenue in Q1 2014 to decrease further, and the market surely didn't like that piece of news as the share price fell by a double-digit percentage. I'm a bit surprised by this reaction as the cash flow statements clearly show that Staples generates in excess of $900M in free cash flow per year or $1.43/share. Even though the free cash flow will undoubtedly be lower this year, I do expect the company to continue to repurchase shares at a faster rate than the decline in free cash flow. I do however expect the free cash flow to stabilize from 2016 on as Staples is making the shift from store sales to online sales and I expect the fixed costs to come down considerably as Staples expects to close 225 shops by the end of 2015.
On top of that, as only 1/3rd of the free cash flow is being used to pay the dividend, I think this dividend is extremely safe. The current yield is 4.12% and this might actually attract some (new) dividend investors.
I'm not sure why the market sent the Staples-shares in a sharp nose dive, as I'm actually quite happy when looking at the cash flow statements. Those show that Staples had a free cash flow of $935M which equates to approximately $1.43/share. This means that Staples currently has a free cash flow yield of approximately 12.5%. I'm not blind for upcoming potential problems and the decline in revenue, but I'm actually convinced that closing stores and increasing the online sales might actually be beneficial for the free cash flow. I expect Staples to continue the current dividend payments of $0.12/quarter for an annual dividend yield of 4.2%.
I currently have a long position in Staples and have written put option which are now in-the-money. I am looking forward to get the shares assigned, as I think the market is currently completely wrong about Staples and I think there's a 50% upside potential from here.
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.
Additional disclosure: I have a long position in Staples and will continue to write put options at various strikes and expiry dates.