Office Depot: Cost Containment Leads to Earnings Beat

| About: Office Depot (ODP)

Office Depot Inc. (NYSE:ODP) recently posted better-than-expected fourth-quarter 2010 results. The quarterly earnings of 9 cents a share portrayed a substantial improvement from a loss of 6 cents in the prior-year quarter, and also fared better than the Zacks Consensus Estimate of a loss of 3 cents.

The Zacks Consensus Estimate had remained stable prior to the earnings release. On a reported basis, including one-time items, Office Depot delivered a loss of 21 cents a share, as against a loss of 28 cents posted in the year-ago quarter.

Despite a low-single digit decline in the top-line, the office supplies retailer was able to earn a profit on the heels of cost containment. Cost of goods sold and occupancy fell 4.2%, store and warehouse operating and selling expenses tumbled 5.5%, whereas general and administrative expenses slipped 9% during the quarter.

Office Depot’s total revenue of $2,961.9 million fell short of the Zacks Consensus Estimate of $2,975 million, and also dropped 3.4% from the prior-year quarter due to soft demand for office supplies in a sluggish economy. The improvement in the bottom-line overshadowed the fall in the top-line.

Segment Performance

During the quarter, North American Retail division’s revenue slid 2.3% to $1,234.3 million. Same-store sales fell 1% versus the prior-year quarter. Office Depot hinted that customer transaction counts rose compared with the year-ago quarter but the average order value fell in the low single-digits during the reported quarter. The division reported an operating profit of $16.2 million compared with $2.2 million in the prior-year quarter.

Total store count at North America Retail division stood at 1,147 at the end of the quarter. The company during the quarter opened 3 stores, closed 6 stores and relocated 4 stores.

North American Business Solutions' revenue also dipped 2.8% to $797.8 million due to a decline in customer transaction counts. The average order value was marginally lower than the year-ago quarter. To our surprise, operating profit climbed 74.2% to $37.1 million, reflecting improvement in gross margin and effective cost management.

The International division’s revenue declined 5.3% to $929.9 million (in U.S. dollar terms). The division posted an operating profit of $20.6 million, down 67.7% from the prior-year quarter, reflecting a lower gross margin.

International division ended the quarter with 97 company-owned stores. The company opened 1 store and closed (or deconsolidated) 45 stores during the quarter.

Other Financial Details

Office Depot, the operator of office supply stores under brand names such as Office Depot, Foray, Ativa, Break Escapes, Worklife and Christopher Lowell, generated negative free cash flows of $27.9 million during the quarter compared with a negative free cash flow of $27.5 million in the prior-year period.

The company ended the quarter with cash and cash equivalents of $627.5 million, total long-term debt of $659.8 million (reflecting debt-to-capitalization ratio of 45.9%), and shareholders’ equity of $778.4 million, excluding non-controlling interest of $0.5 million. Capital expenditures for the quarter were $49 million.

Our View

Office Depot is repositioning itself to remain afloat in a difficult consumer environment. The company is containing costs, closing underperforming stores, reducing exposure to higher dollar-value inventory items, shuttering non-critical distribution facilities and focusing on providing innovative products and services, which should all contribute to margin improvement.

Furthermore, the company has always been looking for accretive opportunities to enhance its global footprint. Office Depot is reviewing capital-efficient opportunities to expand its reach in Eastern Europe and South America. The company believes that India and China will provide significant growth opportunities going forward.

Office Depot recently announced its plan of acquiring Swedish office supply company, Svanstroms Gruppen. The acquisition will facilitate Office Depot to expand its European market presence, placing it among the leading office supply companies in Sweden.

The company has also initiated a restructuring program to revive its falling sales and managing costs effectively.

However, we remain cautious about the sluggish recovery in the economy. As a result, consumers and small businesses still remain watchful about their spending on big-ticket items such as business machines and other durable products. We observe that the demand for office products is closely tied to the health of the economy.

Given the pros and cons we prefer to have a long-term Neutral rating on the stock. Office Depot, which competes with Staples Inc. (NASDAQ:SPLS) and OfficeMax Inc. (NYSE:OMX), holds a Zacks #3 Rank, which translates into a short-term Hold recommendation.

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Tagged: , Specialty Retail, Other, Earnings
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