The Amazon: A river in South America. Not the best place to take a casual swim as it is populated by piranha, enormous anacondas and caiman, a reptile closely related to alligators and crocodiles.
Amazon: A female warrior. Not the girl you want to marry if you have a dream of seeing your sons surpass your athletic achievements, as Amazons usually kill any male offspring.
Amazon (NASDAQ:AMZN): A company that frightens any person with a career or investment in the retail industry.
Whenever I anger my wife, she has taken to shouting, "I hope Amazon leaves all of your investments trapped in a secular decline!" Meanwhile, my next-door neighbor discarded the boogeyman and now tells his children Amazon will get them if they misbehave.
All joking aside, it is difficult to read an article related to retail investments without hearing a claim that Amazon will destroy every retail establishment on earth. There are those who apparently believe every shopping center will be converted into homeless shelters to house unemployed retail workers.
Nonetheless, there is no doubt that Amazon permanently and drastically altered the retail industry. Consequently, with its robust online sales, it surprises me that Staples (NASDAQ:SPLS) is considered a moribund enterprise by many investors.
Following Staples disappointing fourth quarter results and the proposed shuttering of 225 stores, the stock suffered a double-digit percentage drop. However, I maintain the loss in share value is likely a classic example of market over reaction to unpalatable news. It is my contention that Staples offers numerous positives that will support a more robust share price moving forward. Therefore, Staples presents an interesting trade prospect, and those positives may create a viable investment opportunity.
Retail establishments paid a heavy price far too often embracing e-commerce reluctantly, but Staples now boasts the second largest e-commerce site in the world. Staple's site is thriving. While same-store sales suffered a 7% decline in the fourth quarter, online sales increased by 10%.
Furthermore, the company is not sitting on its e-commerce laurels. Staples.com increased online offerings five-fold last year to 500,000 SKUs. By the end of 2014, Staples will boast 1.5 million products on its site. To advance its online offerings, in October of 2013, Staples acquired Runa, an online service that increases sales by personalizing the shopping experience.
Around the same time, Staples teamed up with Profitero, a provider of online competitor pricing data. Profitero monitors the products of 4,000 e-commerce retailers to ensure Staples maintains competitive pricing. To better combat Amazon, in November, Staples announced a price matching policy allowing its retail establishments to meet Amazon's prices (previously Staples matched Amazon prices online but not in-store).
Staples operates in three segments: North American Stores & Online, North American Commercial and International Operations. The North American Commercial segment provides products and services to companies with 20 or more office staff as well as educational institutions. For the full FY 2013, the North American Commercial segment increased sales by 1% (adjusted for a 53-week FY in 2012).
The weak spot in Staples' business model is International Operations. While International Operations account for 18% of revenues, the segment provides no profits. For FY 2013, International Operations suffered an 11% drop in sales. Store closures accounted for 2% of the loss and unfavorable foreign exchange rates also contributed to 1% of the decline.
Although the closure of 225 retail stores may appear a draconian measure to some, I believe it is indicative of a company acting proactively and aggressively to the changing retail environment. Previous and planned store closures should result in lower Capex costs. Because of the restructuring plan, Staples estimates reduced costs of $500 million a year by 2015.
One should also note Staples closed 104 stores in 2012, 56 of those stores being in the International Operations segment.
Staples strategy moving forward is to transition to smaller stores, each complemented by an e-commerce kiosk on site. New stores, measuring 12,000 square feet, will support 95% of current sales. To date, Staples has approximately 200 stores of 14,000 feet or less in size. Consequently, the format has been vetted and should stand the test of time.
I see other positives capable of supporting a higher stock valuation in the future:
Staples has significant free cash flow. Management projects $600 million FCF in FY 2014.
Staples currently boasts a dividend of 4.25% with healthy dividend coverage. That dividend should work to support Staples' share price.
The company has a reasonably aggressive stock buy-back history, and the program is expected to continue in the future.
The merger of Office Max and Office Depot (NASDAQ:ODP) should result in decreased competition, particularly in relation to retail stores in North America. In the fourth quarter, Office Depot reported operating losses of $118 million versus an operating profit of $5 million in the same quarter of 2012.
Office Depot executives are tight lipped concerning future planned store closures. However, in the fourth quarter of 2013, the company closed sixteen Office Depot and seven Office Max stores. It is reasonable to consider additional store closures as a foregone conclusion.
In summation, Staples' e-commerce site and North American Commercial enterprise are healthy segments of company operations. Store closures and other restructuring efforts should result in $500 million in reduced costs by 2015. The new stores will result in reduced Capex expenses while supporting 95% of current sales volume. Strong free cash flow should allow the company to remain healthy through the restructuring period.
As I write this article, Staples stock price hovers a bit above its three-year low. Overall market action indicates there may be more downward pressure on the stock. It is my contention the market has overreacted and the share price will rebound. I intend to take a small position in the stock when the market opens Monday morning and await price action in the coming days.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SPLS over 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.