Office Depot Is Ready to Rise

05/09/2007 12:00 am EST

Focus:

Vahan Janjigian

Editor, Bottom Line's Money Masters Stock Report

Vahan Janjigian, editor of Forbes Growth Investor, says office supply chain Office Depot should see its sales grow and margins expand, leading to higher earnings ahead.

Office Depot (NYSE: ODP) is a leading office supplier, servicing customers worldwide through its retail stores, direct mail catalogs, web sites, call centers, and contract sales force. Office supplies made up 61% of 2006 net sales, technology products generated 26%, and furniture the remaining 13%.

The North American retail segment, which generated 45.2% of first-quarter 2007 revenues, operates 1,174 stores in the US and Canada, including 16 new stores that opened during the quarter. Many stores also offer printing, copying, graphic design, and shipping services.

The North American Business Solutions segment, which accounted for 28.4% of first-quarter revenues, offers business products and services to small and medium-sized corporate customers who access product information and place orders online or through catalogs and call centers. ODP also has a contract sales force that serves large customers and provides services tailored to their specific needs.

The International segment generated 26.4% of first-quarter revenues. It includes direct and retail sales operations in 42 countries across Europe, Asia, and Latin America. There are wholly-owned or majority-owned stores in France, Japan, Hungary, Israel, and South Korea, as well as licensed operations or joint ventures in Latin America and Thailand.

Operations have improved ever since new management took over in 2005. The pro forma operating profit margin expanded to 5.5% in 2006 from 4.3% 2004. A remodeling initiative is boosting sales and profits by providing a better shopping experience and lower operating expenses.

ODP expanded its line of private-label goods, which offer better value to customers yet carry higher margins. Private-label sales now generate about one-fourth of net revenues. However, North American sales have been depressed as customers put off computer purchases in anticipation of Microsoft’s Vista operating system. Furniture sales have also been soft.

Nevertheless, increased profitability more than offset weaker-than-expected top-line growth. First-quarter net sales increased 7.3% year-over-year to $4.09 billion. North American retail climbed 3.2%, with comparable store sales declining 3%.

Lower margins from international acquisitions, higher paper costs and a less favorable sales mix depressed the gross profit margin by 41 basis points to 31.09%. However, improved efficiencies boosted the pro forma operating profit margin to 5.84%. GAAP net income was $155.8 million, or 56 cents per share, compared with $129.5 million, or 43 cents per share in the same quarter the previous year.

Sales should rise as Vista gains acceptance. Any remaining weakness in comparable-store sales should be offset by margin expansion. All older format stores should be remodeled within the next few years. About 350 new stores should be opened by 2008. The combination of top-line growth and expanding margins should help earnings grow at mid-teen rates. (Office Depot closed at around $34.50 Tuesday—Editor.)

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