A few weeks ago, I published an article on a controversial utility with the theme from a Mick Jagger and Peter Tosh collaboration titled, "Keep on Walking, Don't Look Back". A follower posted his opinion that the theme from the 1966 hit by the Left Bank, and two years later by the Four Tops, "Just Walk Away, Rene" would have been a better title. My opinion is this theme would be most appropriate for Staples Inc (NASDAQ:SPLS). Recent operational missteps and the longer-term outlook imply further problems ahead. Staples is a great example of the cyclicality of retail investing.
SPLS recently reported 4th quarter and full year 2013 earnings and they were very weak. Fourth quarter earnings per share dropped 28% over last year and were below the most recent consensus estimates. Consensus was for $0.39, and actual results came in at $0.33, for a 15% surprise to the negative. Earnings estimates for this year and next have been adjusted downwards as well, with a consensus of $1.10 to $1.06 for both years. Of the 14 brokers that follow SPLS, Yahoo Finance reports 71% have reduced their 2014 and 2015 expectations over the last 30 days.
The problem for SPLS investors is structural in nature. The most basic difficulty is a history of very low to negative Same-Store-Sales SSS quarterly comparisons. This is not a new phenomenon. The company has had a history of weak SSS, going back to 2006. While there are no investors presentations on their website, Staples does provide data on North American Comparable Store Sales percentages. Below is a table of quarterly SSS figures for Staples going back to 1998.
It should be crystal clear why SPLS is having difficulties - SSS have been negative on an annual basis since 2006. Same-Store-Sales should be a basic fundamental factor reviewed by all shareholders. SSS is a revenue comparison number for the same stores opened for more than a year. This important fundamental removes revenue growth attributed to new store openings. It also is a great indication of how well the store is being frequented by its target customers.
Retailers live and die by two often overlooked and deeply connected matrices: Same-Store-Sales and New Store Openings. Below is a table of Total Store Count, also from the company's website. Of the 664 International Stores, half are in Canada, making the total North American store count at the end of FY 2103 at 1,846 and Europe's store count at 282.
|Total Stores Open End of FY||US||Int'l||Total||New US Store Growth||New In't Store Growth|
Historically, retailers grow earnings by increasing store count and increasing SSS, and it becomes clear the fortunes for Staples are pretty weak with declining SSS and declining store count.
The best time to own retail stocks is when earnings are driven by new store opening growth, as SSS growth is usually in the mid-single digits. It has been over 5 years since Staples has opened new stores at a double-digit pace.
Staples founder, Tom Stemberg, started the company in 1986 when the concept of big box stores was gaining popularity, and was the first to bring this business model to the office supplies segment. It is the same timeframe as when Home Depot (NYSE:HD) began to shake up the building materials retail sector. Staples found its niche in small businesses that were patronizing the local stationery stores for office supplies. Similar to HD, SPLS built stores large enough to accept product shipments direct from the manufacturer, bypassing the traditional intermediary wholesalers. Staples then passed the savings along to the customer, building both client loyalty and a replicable business plan for expansion.
However, over the years, competitors cropped up duplicating their brick-and-mortar business plan. For example, Office Max recently merged with Office Depot (NASDAQ:ODP) to form an even bigger competitor. As internet-based retailers multiplied, office supplies fit the plan of most internet-sold products being small enough to ship via UPS (NYSE:UPS) or the US Post Office. Not only has SPLS seen its market share gobbled up by competitive brick-and-mortar stores, but also its online business has been under attack as well from the likes of Quill and Shoplet.com with over 400,000 office supply products.
The company announced it was closing 225 stores over the next two years in an attempt to bring back growth of profitability. This relates to a substantial 12% reduction in total US and Canada store count. From their above linked press release:
The company initiated a plan to close up to 225 stores in North America by the end of 2015. The company also initiated a multi-year cost savings plan, which is expected to generate annualized pre-tax cost savings of approximately $500 million by the end of 2015. The savings are expected to come from supply chain, retail store closures and labor optimization, non-product related costs, IT hardware and services, marketing, sales force, and customer service.
The savings that will drive future earnings will come from store closings, pressure on suppliers for lower prices, and an "optimization" of its employees - aka employee layoffs. These are not usually the best approaches for growing retail profitability and are signs of a long-term decline in their business model.
With the belief that the only time investors should own retail stocks is when store counts are growing at a faster rate than Same-Store-Sales, it's time to "Just Walk Away, Rene". Not even a current 4.1% dividend yield and 50% payout ratio would entice me to either hold SPLS in a portfolio or to invest new capital. There are better investment opportunities than Staples.
Author's Note: Special thanks to Dividend Sleuth for the theme. For us oldsters, here are videos of both the Four Tops rendition and the original Left Bank version. I also could not resist adding the 1964 song from The Zombies "She's Not There" to complete the trip down memory lane (now racking my brain for a stock to go with The Zombies theme). Enjoy.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.