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Office Depot Receives Upgrade from Barclays

Office Depot Receives Upgrade from Barclays

Office Depot Inc (NYSE:ODP) will report 4Q12 results on Tuesday, February 26, 2013, before the market open. Analysts at Barclays are forecasting 4Q EPS of $0.05. They believe that Office Depot continues to face broad-based challenges and expect sales declines across all three business divisions. However, they expect the company to begin to benefit from its efforts right-size its store base, reign in promotions and generate strong margins. The firm estimate 4Q NA Retail comps of (1.0)%, in-line with management’s expectations for a sequential improvement.

Barclays looks for company-wide EBIT margins of 1.53%, up 33 bps y/y. This includes an incremental 43 bps of gross margin improvements – driven by their view that promotions were kept in check throughout the holiday season and that Office Depot Inc (NYSE:ODP) is successfully executing upon its goals to increase its expo sure to the higher-margin services business.

They are raising their price target from $3 to $5. The new $5 target is based on a multiple 5x the firm’s 2013 EBITDA estimate of $342 million. The prior $3 target was based on a multiple 3x for Barclays’ 2013 EBITDA estimate of $342 million.

In related news, most analysts believe that with ODP and OfficeMax Incorporated (NYSE:OMX) merging. They think it’s likely that we’ll see a significant acceleration in store closures going forward. That said, even with Office Depot Inc (NYSE:ODP) and OfficeMax Incorporated (NYSE:OMX) merged, the fragmented office products industry would remain highly competitive and in structural decline, in their view. Even if large scale closures to occur, some are skeptical that office retailers will be able to effectively recover sales from store closures, given the increasing commoditization of office products and growing irrelevancy of the office-specific retail format.

Analysts at BAML note that, since a peak square footage of ~92mn square feet in 2008, the industry has reduced square footage by nearly 5% primarily through closures and limited downsizings/ relocations. They note that while this can be counted as progress, total office retail space is still ~8.5% above 2005 levels.

A merger between Office Depot Inc (NYSE:ODP) and OfficeMax Incorporated (NYSE:OMX) would accelerate store closings, increase purchasing power, leverage corporate overhead and SG&A costs, and allow for distribution rationalization. Together, we think this could add about $480 million in aggregate value over a three year period. This includes part of the $300 million in initiatives that Office Depot is pursuing as a standalone company.

Synergies! Analysts see a lot of synergies (related: see every merger in history) and believe Staples will be a winner. Analysts at Jeffries believes Staples could see some benefit if  OfficeMax Incorporated (NYSE:OMX) / Office Depot Inc (NYSE:ODP) merge, but the range is wide and likely less than $0.20.

If one assumes that one-third of the store closings in the next three years overlap with Staples, and Staples can capture 20-30% of those sales, then it could see a cumulative benefit to Staples, Inc. (NASDAQ:SPLS) top-line of about $45-$100 million (conservatively assumes 65-100 closures per year). If we then assume that there is 5-10% attrition in the Office Depot Inc (NYSE:ODP) and OfficeMax delivery business, the firm could see another $280-$560 million of sales flow to Staples, Inc. (NASDAQ:SPLS). Assuming 13-15% flow through to the bottom line, those sales could generate $0.05-$0.10 in EPS over a 3 year period.

If Staples were to buy 100-200 stores with store volumes more similar to its own then the analysts could see another $0.04-$0.08 of accretion. The analysts note that this does not take into account the possibility that a combined OfficeMax Incorporated (NYSE:OMX) / Office Depot Inc (NYSE:ODP) business could be more competitive on price, resulting from increased buying power.