Staples, Inc. (SPLS) has recently been experiencing significant headwinds, dropping about 18% from $13.5 to a 52-week low of $10.92 since its most recent disclosure of earnings. While the stock may seem valuable, I disagree. Even if the stock is underpriced compared to the historical P/E ratio (it currently trades at a P/E of 8 compared to a five-year average of 16), it is priced like this due to the company's lack of momentum. The stock has floundered because it lacks revenue drivers moving forward, something I noted before the conference call. Dissecting the Q2 earnings call unveils just this.
Q2 Earnings Call
In what was a disconcerting and perhaps unhappy conference call, Staples reported Q2 results prior to the market open on August 15th, missing analyst estimates. The company posted total sales of $5.5 billion and EPS of $0.18,a 28% decline from Q2 2011 on a GAAP basis and an 18% decline from Q2 2011, excluding a one-time, favorable $21 million cash tax refund in that quarter. This compares to analyst estimates of total sales of $5.7 billion and EPS of $.22.
In light of the poor performance, the company is developing a new plan for asset allocation, cost reduction, and sales growth. Staples noted that moving forward, the most important area for the company is growing the top line overall, even if that involved some losses in margins. Overall, it was apparent that changes regarding the strategy moving forward are required (and perhaps this should have been recognized earlier).
The company was very unhappy with the Q2 performance as top and bottom line trends declined across all business units. Performance internationally continues to be a source of disappointment. Margin decline is especially worrisome, and can be attributed to reduced pricing, paper cost increases that were difficult to pass on, increased labor costs. A Credit Suisse analyst noted in the Q&A that two competitors did not experience such weight on margins and another analyst noted that while retailers noted soft quarters, they saw an improvement in July, while Staples seems to have the reverse trend. Staples blamed declines in computers, soft trends in core categories, and ongoing weakness in the European economy for the poor results.
Q2 Results By Business Unit
North American Delivery: Sales were down 1% to $2.4 billion dollars. Low single-digit sales growth in Staples.com, more than offset by a deceleration in contract services (they no longer work with two large contractors). Operating margin decreased 72 basis points to 7.7%, margin pressures coming from Staples.com and efforts to retain existing customers. Retention and acquisition of customers remains stable, but customers are generally spending less. Thus, existing customer sales will be a driving variable moving forward.
North American Retail: Sales were down 3% to $1.989 billion. Operating income rate declined 59 basis points to 4.4%. Double-digit declines in computer and software sales offset gains in other areas (such as mobile phones and copy and print). Store square footage is generally being drawn down to increase store productivity.
International Operations: Sales were down 18% to to $1.1 billion with a negative operating income rate of -2%, a decline of 325 basis points from the prior quarter. Costs are being removed from the business, but the company has not been able to overcome the dramatic declines in sales. There have been significant steps down in the international business since the back half of 2011, and further changes are necessary.
Full Year Guidance: A Cautious Outlook
Sales Growth: Flat
EPS Growth: Low single-digit growth compared to EPS of $1.37 in 2011.
Stock buybacks throughout the rest of the year can be expected, the dividend program will continue, and debt due in October will be paid.
Based on the call, and my previous analysis of Staples, I believe that investors should stay away from the stock. Management has been moving too slowly to create catalysts for change and growth, and as a result the top line has floundered, while margins have shrunk. The fact that every unit saw diminished sales and margins is particularly discouraging. Moving forward, management itself foresees flat sales growth and is overall cautious moving forward. Sacrificing margins to grow the top line may be necessary, but further margin shrink moving forward is daunting for the stock and in my analysis.
None of the above is positive for the stock: the fact of the matter is, the company is drudging through the mud. From the conference call, there is no reason to expect different or more positive results than Q2 moving forward. Without an obvious catalyst for change (and a still-veiled plan for change moving forward), I would stay away from Staples.