Office Depot: Post Earnings Bargain

Office Depot (ODP) beat first quarter estimates yesterday (see conference call transcript) and the stock is showing a sign of recovery. It’s currently up more than 10%.

The office supply retailer has lost two-thirds of its market value since the end of 2006. The company has not lived up to its potential and a shareholder group has waged a proxy fight to oust both CEO Steve Odland and former CEO David Fuentes from the board. This pressure was intensified after ODP’s dismal showing in the fourth quarter of 2007, when its profit slid 85% and it missed consensus analyst estimates in both earnings and revenues. The activist shareholder group balked at the last moment and the entire board was confirmed at the annual meeting. Yesterday’s better-than-expected results should shore up top management’s position.

The results were not mind blowing, as Office Depot continues to struggle with its heavy exposure to some of the regions hardest hit by a dismal real estate market, namely Florida and California. However, Office Depot was able to improve its bottom line by reducing inventory spending. Earnings per share were 29 cents compared to consensus estimates of 22 cents, beating the estimates by 32%. It may be some time before the stores in Florida and California are back to full strength, as small business consumers are handcuffed by lowered home values and rising energy prices. In the meantime, management should refocus turnaround efforts as the proxy-fight issue has cooled--at least for now.

At present, ODP is attractively valued based on its historic price-to-sales and price-to-cash flow figures. Through a historical back study of what the market was willing to pay for ODP using these metrics, we calculate that the normal range for ODP’s price-to-sales is .32-.63. It is currently 35% below the low end of that range. Similarly, the normal range of price-to-cash flow for ODP is 7.31-14.57 and its currently at 5.86--20% below the low end of the range. Were Office Depot stock to appreciate back to levels within its historically normal ranges, the stock would trade between $16 and $24.

ODP has been beaten down badly and will require significant price appreciation just to return to its normal range. Sales continue to grow steadily--albeit not quite as fast as Staples (SPLS)--but nonetheless a positive sign for a company with such a cheap valuation.

Disclosure: none