We all know the story by now; consumers are strapped for cash, businesses are counting paper clips, and gasoline stations are going defunct despite prices at the pump skyrocketing (operators surprisingly make very little in the way of margin as prices rise, and in fact most cases lose money). Today, the market is faced with another retail sector tragedy: Office Depot (ODP). No, the company is not filing for Chapter 11 protection in the spirits of Sharper Image and Bombay. But, the news was so grim (one could argue that it has been for some time) that one must begin to ponder whether the office supply retail sector will have one less stalwart once the economy awakens from its slumber.
Office Depot is among the worst performing stocks in the market today after management at the office supply chain issued a material 2Q08 earnings warning. Does this news really come as a surprise? The company peddles such items as pens, notebooks, and paper to small and medium-sized business owners, not to mention an array of other consumers, most of which are closing up shop, being laid off, or curtailing discretionary spending. The company noted that North American retail comparable store sales (comps) declined a worrisome 10.0% in 2Q08 year on year, which is accelerated from the 1Q08 drop of 9.0%. EBIT margins are anticipated to have declined 400 to 450 basis points year on year, revised from a 200 to 250 basis point expected decline, and also a quicker pace of erosion from the 1Q08 fall of 281 basis points.
In light of this news, the company's stock is trading at a 41.0% discount to book value, which may start to gain the attention of private equity in this fundamental analyst guru's eyes (see Circuit City (CC)). Additionally, the stock is trading at a PE of 5.7 times estimated 2009 earnings, a discount to the sector average, and its closest peer Staples Corp. (SPLS) at 13.22 times. Nonetheless, one could make a strong case that the stock should get even cheaper in the months ahead, pending visibility as to when comps or EBIT margins stand to bottom (perhaps not well into 2009). Management signaled that key fundamental trends could stabilize in the second half of 2008, though we have our doubts given economic conditions, the company's high level of debt, and misaligned inventory balance at this point in the year.
Written by Brian Sozzi, a Research Analyst for Wall Street Strategies (www.wstreet.com) specializing in the apparel/hardline goods sectors of the retail industry.