Are Shorts Right About Staples?

With shares of Staples (NASDAQ:SPLS) trading at around $15.50, is SPLS an OUTPERFORM, WAIT AND SEE or STAY AWAY? Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

C = Catalyst for the Stock’s Movement

Staples has performed well this year, but is this trend sustainable? Longs will say yes, and they will most likely point to the merger between Office Depot (NYSE:ODP) and OfficeMax (NYSE:OMX). This merger will lead to many store closings for both Office Depot and OfficeMax, which will in turn lead to increased market share for Staples. As mentioned in the previous Staples article written for this column, Staples is well-positioned for the short term (for a trade), but the long-term prospects aren’t good.

To put it simply, Staples will be competing against the largest brick and mortar retailer in the world in Wal-Mart (NYSE:WMT) and the largest online retailer in the world in Amazon (NASDAQ:AMZN). What makes this situation even worse is that Staples is selling its products for much higher prices. For instance, the average price of a product that is sold by both Staples and Amazon is 19 percent higher at Staples. In an economy where the consumer is displaying strength, this could be looked at a positive for investors. However, that doesn’t describe the current situation. Consumers are currently looking for value over quality.

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Staples is cutting costs and more focused on its online operation. The cost-cutting could lead to earnings improvements in the near future, but investors want long-term returns. As far as Staples.com is concerned, traffic has been impressive over the past three months. According to Alexa.com, pageviews-per-user has increased 4.4 percent to 4.79, time-on-site has increased 1 percent to 4:41, and the bounce rate (only one pageview per visit) has declined 5 percent to 31.5 percent. These are all good numbers. Last quarter, online sales increased 3 percent on a year-over-year basis. Staples is doing something right in this area. However, it might just be that consumers are becoming aware of the site, which has led to increased visitation. It will be interesting to see if the positive traffic numbers above are sustainable.

Staples is also cutting costs by reducing square footage in its retail stores. At the same time, it’s selling interesting products such as popular mobile devices and 3D printers in order to attract consumers to its stores. This tactic might have short-term effects, but once again, is it sustainable?

Staples is currently trading at 11 times forward earnings. This might look appealing considering Office Depot is trading at 52.5 times forward earnings, and OfficeMax is trading at 15 times forward earnings. However, Staples has had some margin problems. For example, profit margin is currently -0.94 percent, which puts Staples at the 55th percentile in the industry. Profit margin has ranged from -9.39 percent to 5.04 percent since 2011. This isn’t a range that will lead to increased investor confidence. On the other hand, operational cash flow is solid at $1.42 billion. Another positive is the 3.10 percent yield. If Staples can effectively cut costs and increase profits over the next few quarters, then there will be potential for more capital to be returned to shareholders.

In regards to company culture and leadership, employees rate the company culture as subpar and leadership as slightly above average. According to Glassdoor.com, employees have rated their employer a 3.0 of 5, and 46 percent of employees would recommend the company to a friend. For leadership, 60 percent of employees approve of CEO Ron Sargent. The leadership number is impressive considering recent industry challenges.

Let’s take a look at some more important numbers prior to forming an opinion on this stock.

T = Technicals Are Strong

Staples has been a strong performer this year. Is it possible for this momentum to continue?

1 Month Year-To-Date 1 Year 3 Year
SPLS 10.27% 37.32% 27.99% -22.54%
ODP 6.20% 27.90% 107.7% -22.31%
OMX 6.81% 27.39% 193.0% -24.30%

At $15.50, Staples is trading above its averages.

50-Day SMA 14.25
200-Day SMA 13.09

E = Equity to Debt Ratio Is Normal

The debt-to-equity ratio for Staples is close to the industry average of 0.30.

Debt-To-Equity Cash Long-Term Debt
SPLS 0.32 1.44B 1.97B
ODP 0.64 549.26M 653.57M
OMX 0.85 579.16M 972.16M

E = Earnings Have Weakened

Earnings have weakened on an annual basis, but this has led to Staples increasing its cost-cutting measures. Therefore, earnings might bounce back this year. On the other hand, it’s difficult to determine what will happen on the revenue side.

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Fiscal Year 2009 2010 2011 2012 2013
Revenue ($) in millions 23,084 24,275 24,545 25,022 24,381
Diluted EPS ($) 1.13 1.02 1.21 1.40 -0.31

Looking at the last quarter on a year-over-year basis, revenue and earnings have declined. However, while revenue declined on sequential basis, earnings improved.

Quarter Apr. 30, 2012 Jul. 31, 2012 Oct. 31, 2012 Jan. 31, 2013 Apr. 30, 2013
Revenue ($) in millions 6,104.83 5,498.50 6,353.14 6,567.98 5,814.57
Diluted EPS ($) 0.27 0.18 -0.89 0.12 0.26

Now let’s take a look at the next page for the Conclusion. Is this stock an OUTPERFORM, a WAIT AND SEE, or a STAY AWAY?

Conclusion

Staples had been a long-term winner, but it has underperformed the market during a massive bull run over the past several years. If a stock can’t trade higher with the majority of the market in such an environment, then there is an underlying problem with the company or industry. In this case, it’s the industry. Staples currently has to deal with weak international operations, a weak consumer in the United States, and amazingly fierce competition. All that said, with effective cost-cutting measures in place and increased market share likely after the Office Depot/OfficeMax merger, there is short-term potential.

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Staples might OUTPERFORM in the near term, but it’s a long-term STAY AWAY.

Using a solid investing framework such as this can help improve your stock-picking skills. Don’t waste another minute — click here and get our CHEAT SHEET stock picks now.

All content posted should not be considered professional advice. Please do your own research and consult with a professional financial advisor before making any investment decisions. I don’t have any positions in this stock.

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