Summary
1)Staples unprecedented quarterly earnings run of positive store comps has ended abruptly, further evidencing the continued and potentially growing weakness of the US small and midsize business economy. 2)Citing a "tough retail environment" which translated into much lower sales of high ticket/durables such as furniture, business machines as well as basic core supplies, it appears that Staples same store declines in Q2 could well be a harbinger for a very tough back half and holiday season for many chain retailers. 3)The importance of topline revenues in the Back To School season become even more magnified with the uncharacteristic retail store decline in Q2. 4)By all indications, the consumer and business with cash to spend in the back half may find themselves in a paradise of promotions and perhaps, even price wars in the traditional retail sectors. 5)Key suppliers to the OSS such as ACCO, Avery, Mead and others could face cancelled or at minimum, reduced orders in Q's 3 and 4.
Analysis
Staples, long a bellweather of earnings, robust economy and all that is good regarding sustained growth has become the latest comp store victim of the stalled housing and sub-prime mortgage market. I can't recall Staples EVER posting negative store comps in their 20+ year history and fear that when a company with as solid a Leadership Team and Business Model as they have stalls, then we probably have not seen the bottom of the economy in terms of where FY 2007 will go. Although corporate America and big business has shored up both the overall economy and the DJIA up to this point, the handwriting is already on the wall for the anemic financial state of small and midsize businesses that have felt the pain of gas prices, general consumer prices and the ripple effect of disastrous existing housing markets and new construction stats. Peeking back into Q1 earnings releases, both Staples and Office Depot spoke directly to softness in the small and midsize business sector with reference to lack of footsteps and purchases of durables like furniture and business machines. Sure, all businesses will continue to need the essentials like copy paper, envelopes, pads and pens and will continue to purchase these categories regardless of where the economy goes; however, the same cannot be said of purchasing those "luxury" items like PC's, laser printers, chairs, desks and file cabinets and smaller companies will simply do without, get out the duct tape to hold the desk drawer together for one more year and keep the old dependable inkjet printer that's slow but dependable(and paid off!).
On a slightly more positive note, Q3 for Staples and chief rivals OfficeMax and Office Depot provides a chance for the start of a turnaround and momentum building during the Back to School season. Given the strength of sales of big ticket student items like CPU's, laptops, printers, calculators, dorm furniture along with all the great, high margin accessories like ink, lamps, networking and connectivity devices that go hand in hand with these purchases, there is huge upside opportunity to tap the deep pockets of the student customer. Generally speaking, BTS has become the second largest selling season in the Office Supply sector and one which produces high dollar rings, great market basket opportunities and tons of margin dollars from the binders, spiral notebooks, pens/pencils, backpacks, locker products and a slew of many other must have essentials for every student. Average retail rings that hover around $42-$50 most of the year from the average consumer can grow to as high as $300-$500 average from the student shopper depending on school supply lists, demographics, store proximity to universities, and more often, the need for today's student to just have it all and be "in fashion" when classes begin.
The sector player that gets this season right in terms of brand, marketing, assortment, price, fashion and of course, instock, will get the A+ grade at the end of the BTS season and at Q3 earnings announcement time. Having spent 14 years in this sector and knowing the levels of execution of all the players, my money will be on Staples as the school supply HQ of choice for the student and the player with the best grade when the earnings are announced.
