In August 2012, I published an article outlining why I thought Staples (SPLS) was a compelling investment idea (here). Nearly two and a half years later, I’ve started selling my position; while I’m likely to keep a small stake (tracking position) near current levels, I no longer believe SPLS shares are my best use of current resources. This article will address a couple of different areas: first, reviewing my original thesis and comparing it to how things have progressed since then; second, explaining my rationale for paring down the position; and third, a review of the results for SPLS investors over that period.
Revisiting my original analysis
In domestic stores, the company has struggled: same store sales have declined consistently since 2012, without any meaningful help from consolidation / store closures. Now that Office Depot (ODP) and Office Max (OMX, Financial) have merged, we finally have line of sight to a material number of closures in the coming years; whether or not that will result in stabilized / growing comps is still a question mark (with the 2-3% comp growth I was looking for as a result of closures seeming like a stretch compared to recent results: comps fell 4% in North America in the third quarter).
As measured by the last two and a half years, I was wrong about the company’s stores in the United States; they’ve been more troublesome than I anticipated they would be (particularly as the unemployment rate / economy have both started moving in the right direction).
The results in the European business, while quite poor, have not been particularly surprising. They’re much less important to the overall results for SPLS than the North American businesses.
North American Commercial, while outperforming the retail businesses, has also seen its fair share of difficulty. Segment sales were essentially unchanged from 2011 to 2013, with margins contracting pretty severely. While the results have been below expectations to date, I’m encouraged by what I’m seeing: sales momentum has picked up in recent periods (4% constant currency sales growth in the most recent quarter), and I believe margins are likely to improve in the years ahead as the Depot / Max integration begins in earnest (and as Staples starts lapping some investments in their sales force that they’ve made in anticipation of winning new business).
Bringing it all together, the reported results as a whole have been below my expectations; consider how the last few years have played out compared to what I said back in 2012:
“At a recent investor conference, Mr. Sargent said that he believed earnings growth over the next 5-10 years would be in the high single digit to low double digits range.”
For anybody who’s been watching over the past two and a half years, 8% EPS growth as a “conservative” estimate of future earnings growth (as I said at the time) looks pretty laughable. Even with some tailwinds (significantly lower interest payments as the company has repaid hundreds of millions in debt), Staples has trended in the wrong direction on the bottom line. From the time those comments were made, it's unclear if Staples will ultimately be able to report cumulative earnings growth of ~10% in the following five years...
Why I’m selling
Summarizing the commentary from above, I’m still a fan of the Commercial business; recent improvements in results are encouraging, and I think they will continue. Retail, on the other hand, has been worse than I originally imagined: closures have progressed slower than I originally imagined (though that’s starting to change), with an improvement in the overall economy failing to provide any perceivable bump to comps. Management’s decision to increase its focus on selling mobile phones points to the continued problem at retail: there’s not enough merchandise to fill a 24,000-square foot box; the industry footprint must be rationalized through downsizings and closures. Take a trip to your local Staples / ODP / OMX to see this first hand.
With this all considered, in addition to margin pressure and the recent run-up in the valuation (to more than $11 billion as of last Friday’s close), I think the stock has reached a point where I can find a more attractive risk / reward trade-off elsewhere.
There’s one final factor to consider, which I addressed in a recent article (here): I’m not so sure that a potential Staples / Office Depot merger would be allowed; if I believed a proposed deal would go off without a hitch, I would probably hold on to my entire position at current levels.
Returns
I published my value contest submission for Staples on August 10, 2012, with the shares closing at $13.31 per share. On Friday, the stock closed at $17.35 per share; in addition, the investor who has held SPLS over that period (since August 2012) has received $1.18 per share in dividends, for total proceeds of $18.53 per share.
That works out to a total return on the investment of 39.2%, with dividends accounted for as if they were received in their entirety when the stock was sold; based on my math, that works out to a 14.7% compounded annual growth rate over the holding period. If shares start making their way back to the low-teens, there’s a good chance that I’ll start rebuilding my position in SPLS.
