Office Depot: Caught in the Shredder
The pressures of rising prices and falling sales that small businesses are feeling have hit home for office-supply stores as well. On July 8, the sector was shaken up after Office Depot (ODP) said sales at stores open for at least a year sank nearly 10% in the second quarter. The chain will release results for the quarter July 30.
The news sent Office Depot's shares on a 32% plunge, to 7.10. Rival OfficeMax's (OMX) shares also fell, by 12% to 12.18. Shares of Staples (SPLS), the industry leader, fell only slightly—by 2.5% to 22.55—as investors bet that it might be in position to pick up market share from its weaker competitors.
In a release, Office Depot said its margins would shrink as well compared with last year due to "a very difficult business environment." Kate McShane, an analyst at Citigroup Investment Research (C), says profits could come under even more pressure in coming months.
The slump in office supplies might not seem all that surprising, given the generally desperate state in retailing these days. Hundreds of stores have closed in recent months as consumers tightened their spending at everywhere from apparel and shoe retailers including Ann Taylor (ANN) and Foot Locker (FL) to home-goods stores such as Linens-N-Things.
But office-supply chains had held up generally well, bolstered by their core business customers. The last major store closings at any of the big chains came in 2006, when OfficeMax closed 109 stores. Now, though, businesses are also feeling the pinch of reduced consumer spending and tightening credit. According to a May survey conducted by the National Federation of Independent Business, small business optimism is at its lowest since the oil embargo of 1979. And 17% of respondents said inflation is a top concern, compared with 8% only three months ago. "The first concern of small business owners today is inflation—the first time since January 1981," says NFIB chief economist William Dunkelberg.
In a recent report, Stephen Chick, an analyst at JPMorgan (JPM), said the office-goods sector is "under severe pressure, with some of the sharpest same-store sales declines in retail." He added: "We believe some combination of store closings and consolidation is essential over time."
Adding to the woes of the office-supply stores is the low-price lure of Wal-Mart (WMT). As consumers look to cut back on $4-and-up gasoline, they're consolidating purchases of all manner of products into a trip to one store. Recently Wal-Mart also has been aggressively pursuing small businesses with its Sam's Club warehouse club unit, where it has beefed up its office-supplies line with such offerings as ink and toner cartridges and office furniture.
The pressure is showing up in the financial results of the office-supply chains. OfficeMax's first-quarter results were short of forecast and its same-store sales declined 8.7%. Staples is trying to mitigate the effects of the weakened American consumer by expanding overseas—last month it bought Dutch office-supplies company Corporate Express for $2.6 billion. Still, Staples' same-store sales fell 6% in its first quarter ended May 3, and it has cut its outlook for the fiscal year. "The current economic environment is tough," said Ronald Sargent, chief executive officer of Staples, in the first-quarter conference call.
No doubt, Office Depot has problems that are all its own. Shareholders have questioned management's ability to run the business efficiently, and pushed to close some of the chain's 1,600 stores. Dissident shareholders had waged a proxy battle earlier this year and threatened to place their own nominees to the board of directors. But big shareholders Woodbridge Equity Fund and Levitt pulled out of the proxy fight at the last minute, saying they had achieved their goal of drawing attention of the board and shareholders to the unacceptable performance of management. Still, they asked that shareholders withhold their votes for the company's nominees: Chairman and CEO Steve Odland and former Chairman David Fuente.
Chuck Rubin, president of North American retail at Office Depot, acknowledged in a conference call on Apr. 29 that many of the company's new stores have cannibalized sales at existing stores. Consumers in California and Florida, which together make up 26% of the company's total sales, were especially hard hit by declines in the housing market.