Summary
1)After a record setting year in 2006, Office Depot finds itself in a most precarious earnings position for full year 2007. 2)Continued pressure will fall on expense reduction if the all important Back To School season does not play out well for ODP. 3)Competitive growth in new store planned openings has already fallen victim to the soft first half with revised guidance for 125 new stores TY vs 150 previously planned and 150 in 2008 vs 200 originally planned. 4)No viable indications that the soft economy will turnaround in the back half. 5)Potential loss of market share to competition as OfficeMax has announced positive retail store comps in each of the first 2 quarters while Office Depot has posted (3%) and (5%) comps respectively in Q1 and Q2. Staples had positive store comps in Q1 and will most likely post positively again in Q2 despite the soft economy. 6)Anticipated slowdown in old format store remodels to the new Millenium 2 prototype which produce higher sales/sq.ft.
Analysis
Retail store, unfortunately, is not the only segment that experienced a soft Q2. North American Business Solutions(contract) posted a $25 million decline in operating profit on comparable basis reflecting pressures created by lower margin account renewal of large businesses as well as softer than planned sales from small and midsize business customers. When coupled with the added expense of integrating acquired contract businesses from LY(Best-Korea, Papirius-Europe, Allied-US) along with a significant payroll investment to add "foot soldiers" to the Contract sales force, it becomes readily apparent that Q3 and Q4 will need to produce nothing short of spectacular revenue and profitability results if the year end earnings are to be salvaged.
On the positive side of the ledger, ODP has not done alot of "shooting themselves in the foot" in terms of looking to he future. The contract acquisitions previously discussed are negatively impacting earnings currently but are growing revenues by 50%+ and will ultimately provide long term revenue growth potential and market share gains against Staples. The agressive store remodel strategy, again a short term capital expense albatross, will likewise pay future dividends and give ODP the freshest store/customer centric experience within the sector.
The very best retailers don't sustain growth infinitely and occasionally run into bumpy stretches of road. Office Depot can't change the negative aspects of the current soft economy---they can, however, weather this storm with the strong leadership TEAM of Odland, Rubin and Brown, stay within themselves, execute flawlessly, remain positive on long term growth and margin expansion opportunities and continue to evaluate capital spending in an ambitious, yet cautious mode. They've been down this road before in the pre-Odland days and survived the Stapls takeover bid in the mid-90's, which sent them reeling when the SEC ultimately voted it down. They've proven their resilience before and they are not yet down for the count. Coming off 8 consecutive fiscal quarters of double digit EPS growth prior to their fall from grace in Q2 ,2007, they have what it takes to bounce back--a very strong Leadership TEAM and a strong vision of where they are and where they are going in years to come.
