What follows is a list of office retailers with strong upside. In my view, these three stocks are heavily discounted to intrinsic value due to an irrational level of risk discounting. While future streams of free cash flow are usually discounted above 10% for financials and high-risk ventures, it appears that these typically safe stocks are similarly discounted. In the long-term, there is little reason why the multiples of these three companies should be below 10x. Hence, I remain bullish on all three despite recent struggles.
In valuing Staples, I make several assumptions: (1) per annum growth trends around 9.8% over the next half decade, (2) operating metrics are around the 3-year historical average levels, (3) a perpetual growth rate of 2.5%, and a WACC of 9%. These assumptions lead me to a fair value figure of $21.36 for 63.4% upside.
With the stock trading at just 9.3x past earnings with a dividend yield of 3.4%, risk/reward remains highly compelling. Better yet, Staples trades at just 10.5x free cash flow, which is abnormally low for a retailer. Recognizing the value gap, Caris & Co. revised the stock rating from "average" to "above average". Management has also delivered strong execution while mitigating volatility.
Office Depot (ODP)
Office Depot trades at a respective 5.8x and 13.8x past and forward earnings with no dividend yield. It is a highly volatile stock with a beta of 3.3 and thus well positioned to recover lost shareholder value since late March.
Consensus estimates forecast Office Depot's EPS turning positive at $0.03 in 2013 and eventually hitting $0.27 in 2014. Of the last 17 revisions to EPS, all but one have gone down for a net change of -60.7%. According to NASDAQ, the stock is rated around a "hold". With the retailer struggling, it may not be able to fully capitalize off of normalized consumer expenditures. Accordingly, I believe that the firm may be a takeover target.
OfficeMax trades at a respective 15.8x and 6.3x past and forward earnings with no dividend yield. While it is less volatile than OfficeMax, it still is very volatile with a beta of 2.5. According to FINVIZ.com, the target price on the stock is $7.86, which is a healthy double digit margin of safety to the current price.
Consensus estimates forecast OfficeMax's EPS growing by 11.5% to $0.68 in 2012 and then by 10.3% and 13.3% in the following two years. Assuming a multiple of 13x and a conservative 2013 EPS of $0.72, the stock will hit $9.36, implying that the stock will nearly double. While I do not anticipate the multiple normalizing at that level, I expect that the multiple to be met at some point given how volatile OfficeMax is.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.