Lackluster growth in employment and weak capital spending by businesses have depressed sales at Staples (SPLS), a $10.3 billion office supply and services, computer, and office furniture provider. Weak market conditions have also driven the company's share price to as low as $11.94 in the past year.
Still, with net sales in excess of $25 billion a year, Staples is the largest player in the office supply and service business. Even though some investors, such as Jim Cramer, rate it a sell, Staples' rock-solid balance sheet, including $1.2 billion in free cash flow generated in the last fiscal year alone, rising dividends, and fair valuation make it an attractive income and value asset for investors. Staples has more online sales than Wal-Mart (WMT), Apple (AAPL), and Dell (DELL). The company is dubbed the next Amazon (AMZN) in the making due to its burgeoning online sales.
Staples' total revenues have been growing in the low single digits over the past couple of years. The company's net income has rebounded fairly well on cost cutting as Staples focuses on improving profitability. In the most recent quarter, on a 1% increase in total revenue, the company reported earnings per share of $0.41, beating consensus earnings estimates by a penny. This year, the company is expected to report an 8.7% increase in earnings, followed by a 9.0% rise the next year, with a modest sales growth due to persistently soft market conditions in both the U.S. and Europe. With expectations of improving labor market conditions and higher business spending in the future, Staples is expected to grow its earnings 10.7% annually over the following five years. This is 8.8 times faster than in the previous five years, on average.
One of the reasons for strong future growth at Staples is its budding online sales. The office supplier's online sales now account for about 40% of total revenues, which puts Staples right behind the global leader in e-commerce, Amazon. Staples receives about 60% of its total revenues on a business-to-business basis. This model has proven successful and has helped Staples grow its top line.
However, recently, Amazon has ventured into direct online business-to-business sales with its AmazonSupply, an online portal that sells 500,000 items, including office supplies. This has turned Amazon into Staples' major competitor. Thus, the move by Amazon now introduces the risk that the e-commerce giant could steal clients from Staples, thereby adversely affecting the office supplier's sales growth.
Still, Staples' online sales give it a major market advantage relative to its core rivals, Office Depot (ODP) and OfficeMax (OMX). In addition to this advantage, Staples benefits from economies of scale due to its large size relative to its peers. Staples is almost fifteen times larger than its closest competitor, Office Depot, and 27 times as large as OfficeMax. Staples pays a regular annual dividend of $0.44, which translates into a dividend yield of 3.0%. This is about a percentage point higher than the yield on the S&P 500. Neither Office Depot nor OfficeMax pay any dividends. Amazon also does not pay dividends. In contrast, Staples' dividend has increased almost 340% since 2005. The payout ratio has been very low, at 29% of earnings and 23% of free cash flow, which, given the firm's large cash position, suggest that the company has additional room to boost dividends in the future.
Another Staples' advantage is its attractive value. Currently trading at 10.6 times its past earnings, Staples is cheaper than the market on average (S&P500 price-earnings ratio is 51% higher). While Office Depot has a lower P/E of 6x, OfficeMax boast a higher P/E of 11.6. On a forward-earnings basis, Staples has a lower P/E (of 9.12x) than Office Depot (15.3%), but a higher P/E than OfficeMax (6.6%). Now, the differential is particularly pronounced when Staples and Amazon are compared. Amazon, which does not pay any dividends, has a current P/E of 185x and forward P/E in excess of 88x. It is also a striking difference to compare Staples' price-book ratio of 1.47x with Amazon's nearly 14x ratio. Based on the current analyst target price for the company's shares, Staples' stock price could appreciate by more than 21% within a year.
If and when employment growth and business spending on equipment pick up, Staples will see stronger revenue and earnings. This will complement the management's effort to boost the company's profitability. Contribution to growth in both top and bottom lines should also come from Staples' entry into several key emerging markets in South America and Asia. While the company works on its growth, Staples still represents a major play for income and value investors.