This hound has been lazy for past few months. However, with the arrival of the new year and starting with this month I am going to shoot to make one post per month for the blog highlighting a different potential value candidate. Today's post will cover Office Depot (ODP). I understand that this was not on the previous lists that I had made, but I think the business (retail) is a bit easier to analyze than others as well as possible to make comparisons to other competitors that have basically an identical business model.
Office Depot has annual
sales of around $15 billion. The company currently has a
market capitalization of approximately $1 billion. At the recent low for the stock of $1.45 per share the market capitalization was closer to $450 million. The main competitor is Staples (SPLS) which has sales of around $18 billion. Staples has a market capitalization of approximately $14 billion. During good years the companies can expect a net profit margin of approximately 5% of sales and PE ratios of around 10. Based on both of their sales respectively we could anticipate
normalized net profits of around $750 million for Office Depot and $900 million for Staples. Applying a PE ratio of 10 to both would give $7.5 billion market cap for ODP and $9 billion for SPLS.
It appears that Staples already commands a premium valuation when compared to ODP in terms of higher PE ratio and also higher price to sales ratio. A good question would be whether or not Staples is worth 15X more than Office Depot. I think the answer is a definitive NO - and value hounds would be way more interested in Office Depot than Staples.
If purchases were arranged during the next market selloff for the $1 range ODP could be purchased for $400 million value and potential 10 - 20X appreciation over the following 3-5 years as normalized value returns.
However, instead ODP is priced for an impending bankruptcy filing. Why is this and how can we evaluate whether ODP is in big trouble?
The first piece of the puzzle is the balance statement - we need to look at how leveraged ODP is (how much debt) and also how liquid it is (how much cash available). It is also useful to analzye the terms of the financing provided to ODP to see if there is some concern about how that financing might be renewed.
Balance Sheets are snapshots of a static moment in this time. The most recent public information for ODP is for the third quarter ended 9/27/08. The items that instantly stand out are cash of $400 million and short term debt of $400 million as well as long term debt of $500 million and long term liability charge of $500 million. The accounts receivable, inventory, and accounts payable are only an issue to the extent that we see any of them building consistently from quarter to quarter. This is not yet evident, although you would expect it if the retail recession continues.
The $400 million in cash is encouraging but doesn't tell us that much other than ODP should be able to whether a few bad quarters based on its reserves. The more important questions are regarding the debts and long term liability charges. The short term debt of $400 million was obtained under a credit facility agreement with a facility of Lenders headed by JP Morgan. The lending facility provides for up to $1.25 billion of borrowing and does not expire until October 2013. The length of the agreement (5 years) is key as things could be bad in the retail sector for a while.
A copy of the credit agreement is a public filing and is available here.
The interest rate was complicated to calculate being a composite of several factors. The key thing to understand about it is that it is a variable rate credit facility and it is tied to the Prime Rate + 1% + an additional 2-3% profit spread. Based on a current prime rate + 1% of 4.25% you can estimate that the current interest is ranging between 6-7% annualized which is a great interest rate for Office Depot. There is of course risk if interest rates increase.
The long term debt is composed of $400 million worth of senior notes with interest at 6.25% (apparently fixed) and maturing also in 2013. The additional $100 million of long term debt is an additional borrowing under the credit facility that the company expects to pay off in the long term as opposed to short term category.
What are the long term liability charges of $500 million? They have to due with unfunded pension costs, income tax liability, and also lease obligations.
Now that we have a bit of a handle for the exposure if the company was to keep losing money or start to lose more money, we can examine the cash flow to see how much cash the company is burning through each quarter.
Cash flow information on Yahoo finance is always a little dodgy so above numbers should be double checked. The standout highlights though are capital expenditures of $100 million per quarter. These relate to the opening of new stores and build out of the company's operations around the world. The cash flow statement already takes into account interest payments of about $20 million per quarter for ODP, so the main issue is capial expenditure. If the company throws off operating cash flow of $100 million per quarter as it has been, it can cover the quarterly capital expenditures without too big of an issue. If business deteriorates and operating cash flows go negative or much lower the company will have to cut back additionally on capital expenditure.
In fact, that is exactly what the company has already begun to do:
Press Release Print Page | Close Window Office Depot Announces Update of Strategic Review BOCA RATON, Fla., Dec 10, 2008 (BUSINESS WIRE) -- Office Depot, Inc. (NYSE:ODP), a leading global provider of office products and services, announced steps to be taken as part of the strategic review announced on October 29, 2008. The Company plans to close 112 underperforming retail stores in North America over the next three months, reducing the North American store base to 1,163. The stores to be closed are located in various geographic regions, including 45 in the Central U.S., 40 in the Northeast and Canada, 19 in the West and eight in the South. Additionally, 14 stores will be closed through 2009 as their leases expire or other lease arrangements are finalized. New store openings for 2009 now have been reduced to approximately 20, down from the previous estimate of 40 stores. This will facilitate a reduction in total Company capital spending in 2009 to less than $200 million, significantly lower than projected depreciation and amortization of $275 million. Office Depot also plans to close six of its 33 distribution facilities in North America. This is consistent with the Company's long term plan to reduce the total number of facilities and combine its separate supply chain systems. The Company anticipates taking charges in the fourth quarter 2008 and in 2009 for these actions totaling in a range from $270 million to $300 million. The cash component of these charges is projected to be approximately $40 million over the next twelve months and is comprised of continuing lease payments on closed stores; and severance for store, headquarters and field sales staffing; partially offset by cash received for liquidated inventory and assets. The remaining non-cash and future cash charges of approximately $230 million to $260 million are comprised principally of fixed asset write-offs and lease reserves on closed stores. These actions should benefit 2009 EBIT and cash flow by approximately $90 million and $70 million respectively. The benefit to cash flow is primarily a result of lower 2009 capital spending, payroll savings and operational improvements from store closures. Further actions are being contemplated and are expected to result in additional charges to be recognized in the fourth quarter of 2008 and into 2009. These actions include the assessment of tangible and intangible assets, including the annual goodwill evaluation, and potentially restructuring businesses. Office Depot has a quiet period policy from its quarter end until earnings are released, during which it cannot have discussions with the investment community. This period commences December 27, 2008, and extends to February 24, 2009. About Office Depot Every day, Office Depot is Taking Care of Business for millions of customers around the globe. For the local corner store as well as Fortune 500 companies, Office Depot provides products and services to its customers through 1,705 worldwide retail stores, a dedicated sales force, top-rated catalogs and a $4.9 billion e-commerce operation. Office Depot has annual sales of approximately $15.1 billion, and employs about 49,000 associates around the world. The Company provides more office products and services to more customers in more countries than any other company, and currently sells to customers directly or through affiliates in 48 countries. Office Depot's common stock is listed on the New York Stock Exchange under the symbol ODP and is included in the S&P 500 Index. Additional press information can be found at: http://mediarelations.officedepot.com. In layman's terms the company is getting rid of the bad locations and focusing expansion and capital expenditures on the most promising international locations. By doing this they hope to maintain or improve operating cash flow while decreased capital expenditures that are wasted on poor / deteriorating locations.
All of these actions are encouraging to me and I don't really see the reason for the bankruptcy concerns other than the godawful stock performance. This one deserves further monitoring. A key item I also took out of the news release posted above is that ODP is going to throw a lot of the costs related to the store shuttering into the next couple quarters. These should produce some ugly earnings reports with big losses in the near term but also could provide a stronger foundation for Office Depot to survive this downturn. What would be a dirt cheap price for this stock? $1 per share. Anything below that and the stock runs danger of delisting / also shows strong signs of bankruptcy looming.
Here are a few charts of ODP.
Long Term:
1 year chart:
An encouraging sign I am looking for is for the stock to retest the lows around $1 per share following the bad news of the next couple quarters. I would then like to see the stock stabilize and follow a trading range in the $1-5 range for the following 12-18 months. This would be the ideal accumulation zone as you would have a better feel for the bankruptcy issue / deteriorating retail environment.
So hounds what do you think? How about some constructive criticism.......a la - what am I missing here?
