Executive Briefing: Staples leading the way

 

Positive retail sales in the US show that Staples is still a step ahead of its main rivals.

 

Staples’ third quarter results yesterday provided a boost, not only to its own share price, but also to those of its main US rivals Office Depot and OfficeMax.

 

After posting better-than-expected retail results in North America, Staples’ share price ended the day up 5 percent, with Depot’s rising 3 percent and ‘Max’s by 8 percent, all comfortably ahead of the Dow Jones which rose by just over 1 percent.

 

The reason for the optimism from investors in the OP sector was Staples’ same-store sales in North America, which remained flat for the quarter ending 31 October, beating analysts’ estimates of a 3 percent decrease. In fact, total NAR sales were up slightly by 1 percent to $2.6 billion, helped by strong technology sales during the Back-To-School (BTS) season and 10 days of Windows 7 sales at the end of the quarter which added around 1 percent to the NAR top line.

 

Staples also saw a 2 percent increase in store traffic for the quarter – the first time this has increased in the last nine quarters. In previous recessions, retail has been the first sector to recover and, if this recession follows a similar pattern, this may be an indication that a positive turnaround – as opposed to things just being ‘less negative’ – is under way.

 

In yesterday’s earnings conference call, Staples CEO Ron Sargent said that he has seen nothing that would indicate that this recession is wildly different than other recessions, suggesting that he expects to see a pick up in the contract business a few months down the line.

 

Whether this is six or nine months – or even longer – remains to be seen. While Staples did say that it has seen some improvement amongst small business customers in its business delivery division, overall North American Delivery (NAD) sales were still down 11 percent, with no sign of a pick up in the contract business and little evidence to suggest that major corporations are going to start hiring again in the near future.

 

In the meantime, Staples continues to outperform its two main rivals in North America. In fact, there is some evidence to suggest that investor confidence in the sector as a whole is somewhat misplaced.

 

Even accounting for the one percent boost from Windows 7 sales in Staples’ NAR results last quarter, it still outdistances Depot and ‘Max by some margin; Depot’s same store comps in Q3 were -14 percent, while comps in ‘Max’s US stores were -10 percent. Staples was able to boast positive comps in its BTS season versus 2008; in its last earnings conference call Depot admitted that its own BTS sales had declined by 8 percent in 2009.

 

Staples has managed to develop a competitive technology offering which is crucial, not only for BTS, but for the current Holiday season which kicked off in the US with the traditional ‘Black Friday’ sales last week. For the third quarter, computers accounted for 9 percent of sales in NAR (up from 8 percent in Q3 2008) and Staples experienced double-digit comps in sales of laptops. While these kinds of products attract lower margins, Staples has managed to protect its bottom line and overall NAR margins only fell by 0.19 percent (to 10.1 percent) in the quarter as selling and operating expenses were reduced, especially in marketing where more online marketing and fewer printed circulars helped lower costs.

 

Staples is also continuing to increase its retail footprint. It is on track to open around 50 new stores in 2009 – including entering nine new US markets – and expects to open a similar number of stores in 2010.

 

While Staples’ NAD unit reported an 11 percent decline in sales, this again compares favourably with Depot and ‘Max, who posted 16.5 and 14.3 percent declines respectively in their own equivalent divisions. Staples maintains that it is continuing to win market share from its rivals and that any attrition from the Corporate Express acquisition is largely due to walking away from lower margin business.

 

In fact, the integration of the former Corporate Express business appears to be progressing without any major hitches in North America. The 2010 full-line catalogue is being shipped out to customers this week and features a common product assortment of 8,800 items, while more than 1,000 items have been converted from the Corporate Express to Staples brand.

 

Profitability of Corporate Express customers has also been improved. Average order size of former Corporate Express contracts has increased from about $160 to $180 (though still short of Staples’ own average of over $220) and the number of Corporate Express orders under $50 has decreased by several percentage points.

 

As Depot continues to be in the spotlight over its public sector contracts and with ‘Max reportedly making major changes in its contract division staffing, the opportunity for either of them to significantly benefit from any openings arising out of Staples’ acquisition of Corporate Express would appear to be well and truly over.

 

If there was to be a blot on Staples’ copybook, it would undoubtedly be with its international operations.

 

Even though top line sales of $1.4 billion in Staples’ International division for the third quarter are some 80 percent greater than Office Depot’s, local currency comps were down 12 percent (compared to 9 percent for Depot’s Q3) and operating margins were down 0.7 percent to just 2.8 percent of sales (versus around 4 percent for Depot).

 

Mike Miles, President International, said that one of his priorities would be to improve profitability of international operations. The company has talked about 7.5 percent operating margins in Europe for some time, but Miles admits that "little progress" has been made in achieving this goal. However, as the focus of the Corporate Express integration moves to Europe, this is expected to help overall profitability. In the last quarter warehouse consolidation was completed in Italy and by the end of this financial year, Staples is on track to close 10 such facilities since the acquisition.

 

Miles also said that he would be looking closely at countries where he felt that profitability could not be achieved in the short term. Staples has recently closed its Hungarian business and is servicing contracts there out of Austria, while Miles also announced that Staples would be closing its two Office Centre outlets in Germany.

 

Two other drags on the business are the European printing business and operations in China, which combined accounted for around $20 million in operating loss in the third quarter.

 

Miles said that steps were being taken to return the printing business – which sells and services Heidelberg printing equipment – to profitability. This is a non-core business and once a "right-sizing" has taken place, it would not be a surprise to see Staples try to offload this unit.

 

China, however, remains a key market for Staples going forward, even though Ron Sargent admitted that it is "not significant" yet to overall results. Sargent also said that the business in China had suffered because it had focused on "too many initiatives there rather then really focusing on the basics", namely selling office supplies to business and government customers. While he did not give an exact timeframe for achieving profitability in China, the Staples CEO did reveal that he would be "disappointed" if operations in the country were not profitable by the end of 2011.

 

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