Staples: The Morning After (The Big Breakup)

| About: Staples, Inc. (SPLS)


Staples reported Q1 2016 earnings, reporting a slight year over year drop in revenues and net income.

Announced sale of the Staples Printing Solutions group for $85 million, in the attempt to focus on the core business.

Proclaimed a renewed focus on streamlining and refocusing the business on North America. Announced the search for strategic alternatives for Staple's European business unit.

Reaffirmed commitment to being shareholder friendly through dividends and buybacks.

On May 18th, Staples (NASDAQ:SPLS) announced their first quarterly numbers post termination of the Office Depot (NASDAQ:ODP) transaction.

This earnings call was of monumental importance, not for the Q1 2016 numbers themselves, but rather for the commentary of Staple's management for post Office Depot plans.

The Numbers

Staples announced Q1 2016 revenue of $5.101 billion, compared to $5.262 billion Q1 2015. The only bright spot was the slight gain in revenue for the corporate contract business to $2.116 billion from $2.108, an increase of .03%.

Staples Retail & Online revenue fell 5.2% to $2.247 billion from $2.372 billion Q1 2015.

International operations fell 5.6% to $738 million from $782 million Q1 2015.

Staples attributed this drop primarily to a slowdown in sales, along with some effects from currency moves.

Total business unit income was up slightly to $192 million from $189 million a year ago. This was attributed to lower sales costs.

GAAP earnings resulted in $.06 per share down from $.09 per share year prior.

Non GAAP earnings were $.17 per share, same as year ago.

You can view the Q1 2016 numbers here.

The Story

Simply put, the numbers are the numbers. Nothing to write home about and more of the same. Revenue is down due to the mediocre economy and overall slowing business. As discussed before, the sole area of growth was the commercial business. Staples is merely managing the retail division while they figure out the next steps.

Personally I found the most value from the conference call itself.

Go ahead and listen to it if you have the time. You can find the replay here.

The conference call started with the first 5 minutes dedicated to Staple's management discussing how disappointed they were that the FTC and the judge denied the buyout.

As someone who has been against this poorly orchestrated financial bailout of Office Depot since day 1, it irritated me to hear Ron Sargent almost give the "poor sap" story of how they were wronged.

Mr. Sargent recited the reasons we have previously heard before, including that the FTC and the Judge failed to consider the retail market and only focused on the corporate Fortune 100 companies, and made the mistake of excluding the ink and toner business. We did get a mention of Amazon Business, a division of Amazon (NASDAQ:AMZN) being a competitor, someone who did not even register as a competitor on the market share comparisons as presented by the FTC.

I discussed this in my last Staples article, "Staples/Office Depot: Picking Up The Pieces." Simply put, the FTC and the Judge made the right call and Staples shareholders should be thankful.

The rest of the conference call was actually inspiring to shareholders and potential shareholders.

First and foremost, we found out the final damage from this breakup.

As we have previously known, Staples is on the hook for the $250 million break up fee to Office Depot, which they state will be paid this week.

Secondly, and what we did not hear much of previously, Staples disclosed that they were responsible for a $69 million fee paid to lenders in order to set up the financing for the planned buy out.

If the total sum for this experiment and what I would consider the "stupid tax" is $319 million, it represents approximately 50% of the estimated $600 million annual Free Cash Flows.

So What's Ahead?

Staples announced 3 things that earned my respect and are now having me consider making an initial investment at these levels.

  1. Staples announced a renewed focus on the core business markets. With that, they announced a deal to sell the Staples Printing Solutions group for $85 million. This will result in a realized loss of approximately $40 to $45 million, of which $32 million has already been recognized.
  2. Staples announced that it is seeking strategic alternatives for Staple' European/International business unit, business speak for selling/divesting. During the Q&A it was stated that during the Office Depot anti-trust due diligence in Europe, Staples identified strong interest from several parties for their European assets.
  3. The focus on Mid Sized businesses. This group is identified as a small company from 10 to 200 employees. This group, unlike an individual is looking for good pricing and has some special needs, however is not reliant on central purchasing and contract pricing like the Fortune 100 do. Staples believes that this is the largest area for growth opportunities for a number of reasons, including a highly fragmented marketplace with a large number of regional competitors, against whom Staples has a number of competitive advantages.

Overall, Staples management has commented that they are looking to grow two ways, first, by driving more online and contract business, and secondly, generating more sales from categories beyond core office supplies.

The category of note was Break Room supplies, including coffee and snacks, particularly as employers are trying to differentiate and attract employees to their companies. A well stocked break-room filled with coffee and snacks is one of those ways.

One other area of discussion focused around dynamic pricing, particularly for online outlets.

One place where this is showing up is the increased margins even through the lower sales revenues that were generated in the previous quarter.

Staples has also reaffirmed plans to close about 50 stores, which would bring the total stores closed to 300.

One note that came about the retail stores is that the average store lease is approximately 3.5 years.

During the Q&A a question was asked whether Staples was looking at store closings as they coincide with the lease terminations, however the question was dodged and left unanswered.

Ron Sargent did bring up that he sees a longer term target for approximately 2,000 office supplies stores in the United States. Staples is currently at about 1,200 and Office Depot over 2,000. Many of those locations are within 5 and 10 miles of each other.

Even though it was hinted that the amount of stores would come down, it was noted that having a retail presence IS a key differentiator and a competitive advantage that Staples has, particularly against regional competitors and someone like Amazon . It was reiterated that unlike retail customers or corporate contract Fortune 100 clients, the mid sized business customer is an "omni channel" customer, meaning that business is just as like to order on as they are to order with Staple's business Quill division or to pick up the items they need at a local store.

It was also noted that Staples has very few stores left that are not profitable.

Finally they outlined their commitment to return capital to shareholders. Management reaffirmed commitment to the current dividend and announced a commitment to begin share buybacks for when it makes sense.

The dividend is estimated to be approximately $300 million along with $100 million for the share buyback.

Bottom Line

For the first time, I am optimistic.

I am optimistic for a few reasons. First, the Office Depot fiasco is done, but most of all, Staples has acknowledged their issues and seems genuinely interested in fixing their business and repositioning for the future.

To me, the conference call felt like they genuinely read my previous articles and decided to do something about it.

Management has indicated that the next 12 months will be a transition period, and I believe I am willing to give it to them.

The current $8 or so per share represent a decent value. As long as the core business does not deteriorate much further, buying in at these levels with the current dividend of 5.83% is a fairly smart play.

Disclosure: I/we 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.

Additional disclosure: Nothing in this article should be construed as investment advice. Please consult your financial professional to see how anything discussed here applies to you. This is not a solicitation to buy or sell any securities. This is not Tax Advice. Please consult your tax professional.