Staples (NASDAQ:SPLS), like its competitor Office Depot (NYSE:ODP), has many retail stores which is causing investors to misunderstand the business opportunity facing Staples. Investors associate Staples' stores as just another retailer. But this is not a true reflection of the business opportunity facing the company.
Staples is pivoting away from solely selling consumer goods towards selling office services. The business opportunity is so great that another competitor, Xerox (NYSE:XRX), has also found itself pivoting towards this business opportunity. To my understanding, there are at least 3 large public companies now attempting to sell services to office customers rather than only selling office products. Not to mention smaller and independent businesses. This implies a highly fragmented and competitive market. Nevertheless, in spite of potential execution challenges, I believe that Staples is still undervalued relative to its full potential.
Starting 2016 Q4, Staples broke down for investors its two operating segments in order to give investors a better understanding of its key business opportunities.
Its two operating segments are North American Delivery (including online and Staples Business Advantage) and North American Retail (more on these to follow). Staples continues to focus on its Staples 2020 strategy, which includes:
- Grow the mid-market in North America;
- Remain profitable in North American stores;
- Cut back on costs throughout the company; and
- Remain focused on North America.
As of the latest quarter, it added an additional area of focus, what it refers to Pro Categories. This includes, facilities, break room, furniture, technology solutions and promotional products. Shira Goodman, the CEO, believes that these core products are what Staples is known for selling already, but together with the company's expertise could lead to a more profitable relationship with customers.
Overall, Staples' business strategies are working as the company's gross profit increased to 26.0% from 25.5% YoY, a level that management believes is sustainable.
North American Delivery
Its Delivery sales were down 2.8% and comps were also down 1%. This decline was driven by declines in office supplies. Over the last several earnings calls, Staples' management has acknowledge that selling office supplies has become too commoditized and difficult to compete on while remaining profitable. It has opted to focus its energy on areas that it can derive better profitability, such as break room supplies and marketing services.
Staples Business Advantage sales was down 2.3% and comps was up 1.2% YoY.
In a previous earnings call, Staples mentioned that approximately 40% of the sales mix of its mid-market come from what it calls "beyond office supplies" and Staples is determined to make this revenue stream contribute to more than 60% of its sales mix. It now calls this sales mix "Beyond Office Supplies Sales" or BOSS.
North American Retail
Its retail segment had a very tough quarter. Sales were down 8.2% and comps were down 6%. The decline was driven by technology products, and again, office supplies.
Staples continues to aggressively close unprofitable stores, closing 18 stores in the quarter. Staples has approximately 1,500 remaining in between the U.S. and Canada.
In spite of a decrease in top line revenue for the Retail segment, Staples continues to cut costs and preserve profitability. This is evident in the fact that operating income was 54 basis points higher at 3.5% versus the same period a year ago. For the first time since Q2 2015, Staples was able to grow its operating income.
Since I first wrote about Staples two months ago, news that Staples was seeking to sell itself has been in the press. Two private equity firms appear to be interested in Staples. It's too early to tell if these firms will ultimately buyout Staples, but since my original article, the company trades at practically the same price in spite of this development of a potential buyout being on the cards.
In spite of any fears that these PE firms do not buyout Staples, the company still has a very strong balance sheet with approximately $240M in net cash.
The company expects to generate $500M in FCF for FY2017. At just under 12 times FCF, personally, I find this an attractive valuation.
Additionally, I also found its competitor, Office Depot, to also be attractively priced (disclosure: I was once an Office Depot shareholder, but I am not currently).
Staples' retail side of operations is declining at quite a clip and is dragging down the company's overall performance. But this fact has created a great opportunity as investors are somewhat despondent making Staples shares a buying opportunity for patient investors.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.