Why Staples Is Not One Of My Dividend Staple Companies

| About: Staples, Inc. (SPLS)
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I Like Stuff on Sale

As a dividend growth investor, I love it when that manic-depressive Mr. Market puts good dividend-paying companies on sale. It makes me want to dig up some of the old Mason canning jars buried in the backyard, pull out the rolled-up cash and back up the truck. And when Staples (NASDAQ:SPLS) went on sale recently, I grabbed the shovel. After all, Staples is the world's largest office products company and, according to its website, it invented the office superstore concept in 1986. I thought maybe it was time for it to become a staple of my dividend growth portfolio.

Why was it on sale? Seems it missed earnings estimates and missed fairly well. With analysts expecting earnings of $0.219 and Staples reporting $0.18, it got hammered. That's not uncommon, and it's often viewed as a buying opportunity to add or pick up new shares of good, solid companies. One of my first principles of dividend growth investing is to surround myself with good companies. So I only needed to answer my own question: Is Staples a good company? What did the numbers say?

Running the Numbers

At the close on Thursday, Aug. 23, the price per share was $10.98, which calculates out to a 4.01% dividend yield. When I started looking at some of the fundamental numbers, they looked good too. Using Finviz, I saw that the P/E is 8.26, the forward P/E is 7.52, the PEG ratio was 0.75, the price/book value is 1.11, price/sales is 0.30, and long-term debt/equity is 0.23 -- all excellent numbers.

What about the all-important, at least to me, safety of the dividend? And has it been consistently growing? Since I like to calculate the payout ratio using cash flow, I went to Morningstar and there I calculated a payout of 18.6% for the trailing 12 months, and 17.6%, 17.9%, 11.3%, 13.7%, and 15.28% for the prior five years, respectively. So it appears having cash to pay the dividend is not an issue.

Is it a growing dividend? Staples started paying an annual dividend in 2004 and then switched to quarterly in 2009. It's on track this year to pay $0.44, up 10% from last year, and since switching to quarterly payments have grown the dividends at 11.11%, 9.09%, and 13.79%. By this time I was drooling.

Staples makes the statement on its website that it is company policy to pay quarterly cash dividends, but its board of directors will make the decision dependent on earnings, financial conditions, and other factors. To me, that's code for "If we have the money, we will; if we don't, we won't." Since I know it knows cutting dividends is stock price suicide, I think Staples would only do that if it was forced to. But I was still a little concerned about its dedication to that since it's only been paying dividends for a total of eight years.

Reading the Tea Leaves

I decided to take a look at Staples' earnings call transcript that Seeking Alpha made available here. I noticed some things in the transcript that gave me pause. On a fully diluted basis, its earnings per share declined 28%. Total company sales declined 3%, and top- and bottom-line trends declined across each of the business units. Its computer sales, core category sales, and retail store productivity all declined. That's not unexpected, economic factors being what they are. But is there more?

Staples' North American Delivery, one of its stronger business units, had sales of $2.4 billion, a decline of about 1% in U.S. dollars driven by non-renewal of two large contract customers because of inadequate returns. This reminded me that the company I retired from had a corporate contract with Staples for office supplies. We would order online and it would deliver directly to the location where the supplies were needed. But changes in our operating methodologies were reducing the quantity of items we were ordering, mostly ink and paper items, one of its cores. That doesn't mean it is necessarily a long-term decline for Staples, but I tend to think my former company is typical of many others and if it's using less, Staples won't be delivering as much. It's also significant to me that one of its largest declines in its North American Delivery was to state and local governments.

Many of the large bricks-and-mortar operations are having troubles, such as Best Buy's well publicized problems, for example. Historically, Staples' major competitors have been Office Depot and OfficeMax. Now, though, I see it as companies such as Amazon, Wal-Mart, Costco, and Sam's Club. Staples is expanding its efforts to grow its dot-com site, which did increase sales but in the low single digits. The company is also trying to increase its presence in mobile technology types of items, such as tablets. In my opinion, to remain competitive, Staples will need to maintain razor thin margins for some time. It remains to be seen just how long it can do that.

Staples has been aggressively trying to expand in Europe. And it appears to be hitting significant resistance with that effort. Its COO and president of international operations admitted that "we continue to take costs out of the business, but we haven't been able to overcome the rapid decline in sales." That's a significant statement to me. It's made even more so by a 5% decline in retail traffic.

In the second quarter, Staples opened six stores and closed five. Staples' CEO stated that one area of opportunity for it in regard to its retail business was not to close stores, but to downsize the size of its stores. While that may be a good move for profitability, it doesn't strike me as a company that's growing the business. Consultants would call it "right-sizing" the store, but I tend to think if it's doing it while simultaneously opening new stores, then that would be growing the business. Since Staples leases a large number of its store buildings, it is attempting to renegotiate leases while at the same time downsizing and remodeling stores.

Staples has recognized many of the issues with which its faced and is working on them. It also repurchased 12.1 million shares in the second quarter, and plan to continue doing that. It remains cash strong with about $1 billion in cash and cash equivalents. As I've previously written, I like simple and the simple question is: Can Staples recover long term? The answer is anything but simple.

My Conclusion

In all honesty, reading through the transcript and attempting to "read between the lines" took the gleam out of my eye for Staples. I know there are some very experienced -- and smarter than I am -- dividend growth investors here on Seeking Alpha who are buying Staples at this level. I would be very interested to hear their thoughts on this. Am I completely wrong, or just overly paranoid? Is there blood in the street and I'm just being a wimp? I realize that at the end of the day, we all have to decide which companies meet our various requirements for investment.

Looking back, Staples looked good, but looking forward it's not so rosy, at least to me. I want to buy my companies for the long term and didn't think I could do that here. As good as Staples numbers looked to start with, I was too concerned with what its potential future looked like long term to keep digging up my Mason jars. So I decided to go ahead and put my shovel back down. Oh, but wait! Coca-Cola (NYSE:KO) is down 6.2% so far this month. I hand my shovel to my wife and say, "Honey, hold this for a minute -- I need to go run some numbers on Coke."

Disclosure: I am long KO. 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.

Disclaimer: I am not a professional investment advisor, just an individual handling his own account with his own money. You should do your own due diligence before investing your own funds.