Office Depot Walks the Tight Rope - Analyst Blog

The change in the demand for office supplies products and services remains one of the indicators that describe the health of the economy. The economy has not completely awaken from the state of hibernation, and amidst such a scenario Office Depot Inc. (ODP) has to walk the tight rope to juggle with unprecedented situation that may hurt its growth prospects.

How the Company Balances

Office Depot is repositioning itself to keep afloat in a difficult consumer environment. The company is containing costs, closing underperforming stores, reducing exposure to higher dollar-value inventory items, shuttering non-critical distribution facilities, and focusing on providing innovative products and services, which should all contribute to margin improvements.

The company in order to drive sales has undertaken initiatives, which include improvement in customer in-store shopping experience, investment in Copy & Print Depot and Tech Depot services, remodeling of stores and introduction of smaller format stores, and margin improvements through rationalization of stock keeping units and product pricing.

In view of this, the company rolled out 8 locations of size 5,000 square foot. Moreover, continuing with its margin improvement initiatives, the company remains committed towards price optimization and effective promotions. Office Depot kicked off a new service model in 300 stores before the end of the year, and plans to initiate the new model in additional 360 stores in the first quarter of 2012, with the expectation of implementing in all the stores by the year-end.

We appreciate Office Depot’s rational approach to slow the pace of stores openings in North America, given the weak consumer environment. The company opened 6 stores in fiscal year 2009, significantly down from 59 stores opened in 2008 and 71 stores opened in 2007.

The company opened 17 stores in fiscal 2010 and 9 stores in fiscal 2011. The company now plans to increase the store count in low-single-digit number in fiscal 2012.

Efforts Reaping Results

Despite sluggish economic recovery and underlying pressure in Europe, Office Depot posted better-than-expected fourth-quarter 2011 bottom-line results. The company reported earnings of 3 cents a share, surpassing the Zacks Consensus Estimate of a break-even. Looking out to the year-over-year performance, earnings marked a sharp improvement from a loss of 10 cents delivered in the year-ago quarter.

Office Depot’s total revenue of $2,969.7 million portrayed a marginal increase of 0.3% from the prior-year quarter but fell short of the Zacks Consensus Estimate of $2,997 million.

Adjusted gross profit increased 6.2% to $900.2 million, whereas gross margin expanded 170 basis points to 30.3% in the reported quarter. Adjusted operating profit came in at $35.8 million compared with $13.4 million in the prior-year quarter, whereas operating margin increased 70 basis points to 1.2%.

The Concerns

We remain cautious about the macroeconomic environment and sluggish job market.The recovery in the economy still lacks luster. As a result, consumers and small businesses still remain watchful about their spendingfor big-ticket items such as business machines and other durable products. We observe that the demand for office products is closely tied to the health of the economy.

Management now expects total company sales for the first quarter of 2012 to decline between 3% and 4% from the prior-year quarter. Moreover, Office Depot expects first quarter comparable-store sales at North American Retail division to be somewhat in line with the fourth quarter of 2011. The company had witnessed a decline of 5% during the fourth quarter.

Moreover, due to high exposure to international markets, Office Depot remains prone to currency fluctuations. The weakening of foreign currencies against the U.S. dollar may require the company to either raise prices or contract profit margins in locations outside of the U.S. An increase in price may have an adverse impact on the demand for the products.

Let’s Conclude

No one can predict the future but genuine efforts are implemented to combat the tough economy. Business budget remains tight, consumers remain cautious than ever before and companies are trying hard to navigate through the challenging maze.

Going by the pulse of the economy and given the pros and cons, we prefer to maintain our long-term Neutral recommendation on the stock. Moreover, Office Depot, which competes with OfficeMax Inc. (OMX) and Staples Inc. (SPLS), holds a Zacks #3 Rank that translates into a short-term Hold rating.

OFFICE DEPOT (ODP): Free Stock Analysis Report

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