Buy, Sell or Hold: Out of Staples (Nasdaq: SPLS)

Staples, Inc. (Nasdaq: SPLS) investors are thrilled as the world's largest office supply company's share price is making new 52-week highs and is up 40% year-to date. Quite remarkable!

Staples shareholders think that the company is making all the right moves toward transforming this big-box retailer into something beyond what the average customer is accustomed to when they think of a Staples store.

In fact, the company has evolved to the point where, unbeknownst to many, it is no longer just a big-box retailer but also the second largest e-retailer behind Amazon (NASDAQ: AMZN) with internet sales totaling $11 billion in 2012, which currently account for more than half of its business today.

Staples is pushing to downsize operations while moving with some success even further into the e-commerce world. The company faces many headwinds as it struggles with the general economic conditions and small business concerns both in the U.S. and abroad.

Staples could very well be fighting the good fight but is it enough...

Staples Shredding Stores

Last year Staples announced that it would reduce U.S. floor space (as well as a number of stores internationally) by 15% over the next three years. Plus, the company has a new goal for its retail locations with more emphasis on smaller locations and stocking them with products that have a higher profit margin.

Staples has closed 48 stores in the past 12 months and recently upped its forecast to close an additional 40 stores and downsize or relocate 45 others by the end of 2013. A wise move since same-store sales for the most recently reported quarter dropped 2% and customer traffic was also down 2% year-over-year.

Sales for the quarter in the combined North America & Online segment were $2.8 billion - down 4% compared to the same quarter a year ago.

In Europe, Staples has closed 49 stores over the past year and the ongoing economic woes of the region are taking its toll on the company. First quarter sales internationally were $1 billion which is a decline of 13% in U.S. dollars compared year-over-year.

Staple's total revenue for the quarter was $5.8 billion, a 3.5% decline, with an EPS of $0.26 compared to $0.28 from the same quarter the previous year.

While the revenue numbers are not impressive, the company has more than likely been undervalued and its share price is finally playing catch up with the overall roaring stock market.

Here is some good news for investors who are looking for future growth:

Firstly, Staples' focus is shifting to growing its online business where the company has seen sales grow 3% versus the prior year. More on this later.

Next is the merger of two of Staples largest direct competitors - Office Depot (NYSE: ODP) and Office Max (NYSE:OMX). As the industry shrinks, the merger of its two closest rivals may give Staples an increase in its market share.

This may seem counterintuitive but it is very likely that the new combined entity will and must reduce overlapping stores. This will give Staples with its new more nimble smaller stores the ability to step in and fill some of the gaps.

Finally, Staples is looking to stem the tide of lower foot traffic while at the same time adhering to its smaller-store ideal of stocking higher-margin products.

To that end, the company has a deal with Apple Computers (NASDAQ: AAPL) to sell Apple products and accessories in its stores. And Staples is hoping to lure in the curious shopper with its partnership with 3D Systems (NYSE: DDD) to sell its ground breaking Cube 3-D printer.

Staples Looking Online for Growth

Challenges are looming for Staples in its retail stores, but the company has a game plan set in motion that it hopes will yield good results. However, the game plan for the increasingly important online segment is not as clear and has left much to be desired.

Granted Staples has seen 3% growth in online sales as mentioned, which accounts for an increasing portion of its sales each quarter. But the competition is not (the tiny by comparison) Office Depot and Office Max. The challenges it faces come in the name of retail giants Costco, Wal-Mart, Target and big-box killer Amazon.

A recent report by William Blair & Co. suggested that 48% of Staples products overlap those found at Amazon. Also, Staples prices were found to be 19% higher than Amazon's. Not a good sign to say the least.

Amazon's ability to put the fear into rival companies' profit margins in a multitude of sectors is well documented.

Staples realizes this direct product-for-product competition is a problem and it is on the path of increasing its line of products beyond just those found in an office supply store.

In the first quarter, the Staples added 20,000 new products to its online store in areas such as teaching, education, office décor, and break room and safety supplies. Over the past year it has added 90,000 new products which generate an additional $1 million of sales per week.

In an attempt to keep the fickle customer returning, Staples has re-launched the Staples Rewards program which offers customers 5% back in rewards on all products and services as well as free shipping with no minimum purchase.

Time will tell if this is enough for Staples to capture a strong enough foothold in the online space where the increased sales will eventually translate to increased profits.

With small business having a hard time getting off the ground and everyone attempting to squeeze every possible penny out of their budgets, it seems that Staples will have a tough time in this environment unless it is willing to slash prices drastically to compete - prices that will put them in a precarious position to garner future profits.

Shuffling Paper

Thus far I've laid out a mix bag of good and bad for Staples. I can even add a couple of more feathers into Staples' cap with expected $900 million of free cash flow for 2013, continued share buybacks and a dividend yield of near 3%.

But that is not enough to get me over the hump to buy the shares. In fact I believe the positives are already built into the share price and its nearly 40% upwards move since the start of the year.

Staples NASDAQ
Source: Yahoo Finance

What does trouble me is the longer term prospects with this sector. With economic woes around the world showing very few signs of abating, where Staples success is so closely associated with the success of businesses in general - I don't want to be a part of it.

Staples battle with some formidable foes in the e-commerce sphere further complicates the issue and therefore I am a SELLER of Staples.

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About the Author: David Mamos brings nearly 15 years of analytical experience to the table with a background ranging from big-picture fundamental analysis to highly technical trading decisions. He began his career working as a financial advisor with Royal Alliance in 2001 and helped clients with portfolio management as well as buy-sell decisions before transitioning to the development, implementation and execution of trading strategies for aggressive investors.