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The Office Product Industry Is Getting Interesting!

Tuesday - 3/19/2013, 11:11am  ET

The office product industry has been hit by a weakening economy and low customer purchases. Furthermore, competition has increased as bigger retailers like Costco Wholesale and Wal-Mart Stores have entered this segment. Also, companies are facing stiff competition from the online retail giant Amazon.com. This has triggered a price war that is hurting margins.

Staples tumbled 7%, to $12.34, the lowest price since January 2013, as it announced weak 4Q results and forecasted lower than expected FY13 outlook.

What does the Office Depot-OfficeMax merger hold for Staples?

Last month, Staples’ competitor Office Depot announced a deal to buy OfficeMax for ~$1.17 billion in an attempt to capture a wider market and generate incremental revenues. The merger will result in combined revenues of about $18 billion, which will still be lower than Staples’ $25 billion sales. Analysts reportedly expect the deal to generate cost synergies in a range of $400 million to $700 million mainly through lower operating expenses as the companies plan to close down ~100 stores. This was a deal long awaited for 10 years after Staples tried to acquire Office Depot in late 1990, but fell through due to anti-trust issues.

Staples doesn’t have to worry about the merger. One, because the combined entity will still be smaller than Staples; secondly, this consolidation could be a blessing in disguise as it would rationalize the competition in the $50 billion industry, thereby helping Staples to increase its market share as the two Companies move into a multi-year restructuring program. Further, due to its ability to stock wider products Staples will continue to enjoy economies of scale in purchasing. It is also expected to derive increased cost savings and increased penetration from its acquisition of European rival Corporate Express.

Turnaround:

Staples is taking the necessary steps to combat the increased competition from its peers as well as Amazon. It is focused on the following 4 key areas:

  • Assortment beyond office supplies: It has increased its online assortments and achieved its goal of 100,000 SKU's. Further by 1Q next year, it plans to introduce Apple products as well.
  • Growing its online business: In order to compete against the online giant-Amazon, the Company has beefed up its online store. At the Earnings call, Staples mentioned that it intends to triple the items offered on its website to 300,000 from 100,000 which will help boost online revenue at a high single-digit percentage rate (+3% in FY12), compared with a single-digit rate for the entire company .
  • Redefining the omni channel-experience: Staples announced a new rewards program offering 5% back in rewards on all products and all services and has also offered free shipping.
  • Accelerating growth in the services business: Copy and print sales and EasyTech services in North American stores and online grew in the high single digits during 4Q12 and Staples intends to maintain the momentum going forward.
  • Apart from the above, the Company is also focused on reducing its North American Retail square footage by 15% by FY2015. In 2012, it cut 2% of its total square footage.
  • Further, it is also cutting its headcount in Europe, its weakest business in international and closed ~15% of its store count in FY2012.

Weak 4Q12 results:

Staples weak 4Q12 sales reflected the continued pressure from the weak economic environment. 4Q12 sales increased 3% to $6.6 billion (missed consensus estimate of $6.71 billion – Source: Marketwatch), mainly due to the extra week in the quarter. Excluding the extra week sale of $461 million, total company sales were down 4% versus the prior year.

4Q12 same-store sales for retail, which exclude staples.com, declined 5% due to lower customer traffic with average order size flat year-over-year.

The weak sales were mainly due to continued weakness in its North American business which was weaker than 4Q11's 1% decline and matched the weakness exhibited by its competitor Office Depot and OfficeMax which reported 6% and 4% respectively. Further, it experienced continued weakness in Europe (comps declined 9%). International profitability also suffered as the company's headcount reductions in Europe and Australia failed to offset lower product margin and sales de-leverage.

Gross Profit Margins declined 60bps but Adjusted Operating margins increased 18 basis points to 7.5% due to lower selling, general and administrative costs as a result of lower incentive based compensation.

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