Staples growth



This week, Staples posted a 26 per cent rise in Q1 profit to $186.1 million on the back of gains in its delivery business and international operations. On the whole, the results seemed to satisfy analysts – and outstripped Q1 profits of rival Office Depot which, in Q1, saw a 12 per cent increase to nearly $130 million.


But analysts raised concern over soft comp sales in the retailer’s North American stores, which rose by a meagre 1 per cent and were down from 3 per cent in Q4 2005 – the softest showing since Q3 2002.


"As Staples celebrates its 20th anniversary this month, we are very proud of what we’ve accomplished," said jubilant CEO Ron Sargent, "but we are even more excited about what lies ahead." That said, Sargent admitted in a conference call that comp sales were "a bit disappointing".


In his research note, Citigroup analyst Bill Sims said: "We believe the overall business remains solid. Core office supplies continue to drive comps, North American delivery is growing in the mid-teens, and European operations continue to improve, with operating profit tripling year-on-year." As a response to the results, Citigroup reiterated its ‘Buy’ rating on the retailer.


Prudential analyst Mark Rowen reiterated an ‘Overweight’ rating on the stock, saying: "In our opinion Staples remains the best operator in the office superstore sector and should benefit from improved business spending in North America and Europe."


Buckingham Research, meanwhile, maintained a ‘Neutral’ rating on Staples’ stock, largely because of lukewarm comp sales, which analyst Dan Binder described as "disappointing". He added: "Despite [the] EPS upside, we think investors may push the stock further in the short term as concerns build around retail comp stores sales and softer gross margin guidance in Q2."


Praise where praise is due. High profits and solid delivery sales at Staples were the result of sound performance across all product categories and channels and Binder expects this trend to carry through. In his research note, he said: "We continue to see management do a great job of reinvesting in its salesforce to drive the top line." The retailer also recorded growth in customer traffic and a rise in sales of core items including binders and ink cartridges, and increased use of copy and print services.


But sales were dragged down overall by softness in big-ticket items like furniture, technology and business software. And this, combined with sluggish estimates for Q2 (overall sales growth is expected in the low double digits; comp sales gain in the low single digits), could point to a worrying trend, says Binder. "Given that Depot has generally done a better job in these areas, we suspect market share shift concerns are rising. Further, flat gross margin guidance for Q2 has probably raised some concerns that the company will need to promote more to regain momentum."


Analysts believe this mild Q2 guidance is likely to be related to paper pricing, fuel cost pressure and expenses from the opening of an Atlanta distribution centre. Furniture and technology will not necessarily continue to drag down overall sales, although there may be issues that need addressing.


Certainly, furniture has not been a strong point for Staples and the company did lose market share in Q1. This is perhaps because OP superstores are not yet fully established in furniture, many companies preferring to source furniture from regional dealerships. Staples also blamed the trend for a demand for furniture shifting towards high-end, pre-assembled furniture and away from self-assembly type furniture of the type the retailer provides. The company is currently remerchandising its furniture category, making changes to its product portfolio, improving its pricing strategy and changing its furniture buyers. Sims at Citigroup said: "While Staples will need to make investments in the furniture category over the next few quarters, we note that furniture is a relatively small percentage of Staples’s total sales (7 per cent at the end of 2005)." As a result many analysts expect the category will get back on track in Q2.


On the technology side, performance was in line with recent trends, which means that laptops are recording strong growth and desktops are weak. Technology shortcomings specific to Staples, meanwhile, are expected to be short-lived. This season tax software packages were bundles, which dropped the average selling price from $70 to $40, said Binder, adding that he does not expect the issue to stretch much beyond April.


Continued growth in high-margin categories such as copy centres, ink and supplies, and the upwards trend in private label will continue to put Staples in an upward curve. Said Sims at Citigroup: "We expect categories such as copy centres and ink (both of which carry higher-than-company-average margins) and continued penetration of its own-brand products to support gross margin improvement in 2006. In addition, we are encouraged that traffic trends continue to improve, and the pricing environment in the industry remains benign."


North American delivery was also a high point in Q1, with profits growing 25 per cent to $130 million (compared to a profit rise of 16 per cent to $180 million in the company’s North American retail business). The sector was driven by strength across all product categories and the addition of new accounts, not to mention improved supply chain and inventory efficiency initiatives. Sims states in his research note that he expects the segment to post mid-teen sales growth in 2006.


The high profit, slow sales pattern was also imprinted in the retailer’s international division. While international profits tripled in the quarter from $3.5 million to $10.5 million, reflecting the first signs of a turnaround in Europe, international sales rose 6 per cent based on local currency values, but slouched 1 per cent in dollars. Staples itself indicated that it was pleased with its international results given the tough economies. "The operating margin in the international segment supports our belief that Staples’ investments in Europe are bearing fruit," said Sims. "…Increasing own-brand penetration and an improving macro-economic picture should also help drive good results going forward."


Binder, meanwhile, was less impressed by the company’s international performance. "While the international performance was ok, it wasn’t great," he stated. "Local currency sales growth of 6 per cent and mid single digit sales guidance for Q2 is at the low end of the company’s full year [share] price from $21 to $26 and can be identified with stable comp store sales in retail, continued gross margin expansion, and a dramatic improvement in Q406 international results. We think there is some risk to the stock in the short run as the market revaluates these assumptions."