Rulers For $0.25! Markers For $0.97! Honey, Get The Kids, Lets Go To Staples! by Jordan S. Terry, Managing Director Stone Street Advisors LLC

I don’t cover Staples, Inc. (NASDAQ:SPLS), nor do I claim any particular expertise in the office/school supply sector or other tangential businesses in which Staples attempts to operate. However, I can’t help but question the strategic thinking behind their current back-to-school commercials/promotions. Check out this extremely dorky “viral” video promotion to see what I mean.

watch?v=RiNzhewb4ZI

“Rulers for $0.25! Markers for $0.97! Honey, get the kids, we’ve got to get to Staples, Inc. (NASDAQ:SPLS) before we miss out on these amazing savings” …said no one.

Let’s just lay out what’s going on here: Pencils, rulers, markers etc. are, by and large, commodity goods with inelastic demand; barring relatively large price changes, there won’t be any significant increase/decrease in the demand for these goods. People need them, people buy them, it’s a pretty unemotional, standard purchase. Kids go back to school, you send ‘em back with some staples (literal and figurative), just par for the course; you don’t really pay attention to the price tag, even with Staples 110% price-match guarantee. (Note: If there are enough people running to grab a price-match on a $1 set of markers, we have a much larger problem on our hands).

Are consumers rushing to buy Staples’ private-label white glue for $0.39 (down from $0.60!) over tried and true Elmer’s for $0.50? I don’t have an answer, but my guess is most families aren’t so down on their luck that they’re sending their kids to (be judged at) school having the ‘poor person’ glue. But hey, I’m 30 and single so what the heck do I know what parents are thinking/doing?

Even if Staples is selling private label basic office/school supplies at 20% higher gross margins according to their most recent 10-k than national brands (and is that 20% higher margin before or after discounts?), somehow I doubt they’re getting much profit out of these commodity goods, at least not enough to move the needle for a $23 billion/year company.

Moving on…

Ordinarily, discounting is a practice one would generally apply to higher-ticket, higher margin, products where consumers are very price-sensitive, things like printers, ink cartridges, laptops, tablets, etc. This is not to say the strategy of discounting low price commodity-like goods can’t work as there are numerous promotional/discounting strategies on lower-ticket commodity-like products that work (or could). Think buy one get 2 ties free strategy for a place like Jos. A. Bank Clothiers Inc (NASDAQ:JOSB), which might work to get people in the door to buy more items at full price (though they also discount everything else, too, defeating the idea).

I’m struggling to figure out Staples, Inc. (NASDAQ:SPLS)’ strategy, though. Is the idea to lure people in for all of their back-to-school shopping needs and maybe, just maybe, they might possibly buy their kid a new iPad or other gizmo while there? Is it to lure them in so they end up buying the expensive (relatively) pens, notebooks, and other stuff with higher ticket prices and margins? I think a less bad strategy would be to drum up interest in the higher-price school supplies, the top of the line notebooks, pens, etc, instead of making their cheaper substitutes even cheaper and thereby even more attractive.

Staples has been getting hit pretty hard by declining sales of “core office supplies” and “business technology” the past few years, which isn’t really surprising since all of these things can be procured online much easier and often, cheaper, even after shipping.

Staples

So what’s the plan? Do a really dorky viral campaign to get parents in the door & try to up-sell them while there? I highly doubt many parents are buying a new computer, printer, ink, tablets, phones, etc when a larger % than ever are more internet/online shopping savvy and are more likely than ever before to have a smartphone with the Amazon (etc) app to check prices.

Broadly, I think Staples, Inc. (NASDAQ:SPLS), much like other lumbering brick & mortar retailers, is in serious trouble long term. More and more people buy online every year, supply chains are getting better and better helping online retailers offer increasingly competitive post-shipping prices and quick delivery, paper and ink are getting less and less popular, and the high fixed costs associated with the brick & mortar (plus online) model all put Staples in a fairly unenviable position.

Despite a solid online retailing operation, the brick & mortar part is a huge, huge drag on the company, and with over 2,000 locations (and the fixed costs thereof), I’m don’t see how the company can compete with pure online retailers without severely restructuring, which would mean huge hits to earnings. Of course, the other option is to keep the physical stores, trying to sell things, anything, that people want, but with that comes pretty significant and in some cases non-cancelable lease expenses which are hundreds of millions of dollars/year, $800mm in 2014 alone. If we capitalize the leases (which go out to 2026), with a present value of approx. $2.3bn (back of the envelope), the balance sheet looks significantly less good (D/E becomes material). The company keeps buying back stock (another ~$500mm authorized under current program), but I don’t think that’s a smart use of cash if we take the long view.

I guess when the company has no real long-term strategy to adapt to a rapidly changing world, they revert to ‘viral’ marketing campaigns in hopes of getting something, anything started.

Good luck with that.

As always:

CAVEAT EMPTOR

Via: stonestreetadvisors