Friday, December 17, 2010

Staples and OfficeMax – same business, different results

In this article we compare two office product distributors – Staples (SPLS) and OfficeMax (OMX). Both sell through retail stores, web and mail catalogs, as well as delivery contracts with larger customers. With annual sales of $24B, Staples is more than 3 times larger than its rival, which generated $7.2B in sales last year. But the differences go much deeper than size. From the perspective of long-term shareholders, Staples exemplifies a consistently profitable business that is good at allocating and growing its capital. OfficeMax, on the other hand, is a story of capital tied up in barely profitable operations, and diminished by corporate actions

Over the past 14 years, Staples has nurtured the equity of its shareholders from $1.27 per share to $9.37 – representing a compounding annual growth rate (CAGR) of 15.3%. Including dividends, the shareholder wealth grew from $1.27 to $11.18. That’s a solid CAGR of 16.8%.

(circled letters are corporate event indicators that you can explore on the web site; "M" indicates M&A activity)

The equity of OfficeMax shareholders, in comparison, has been mostly flat, with no compounding to speak of, and significant equity destruction in recent years.

OfficeMax as we know it was formed in 2003, when Boise Cascade Corporation, a paper and wood products manufacturer and office product distributor, acquired the original OfficeMax, Inc. (data prior to 2003 is for Boise Cascade). The paper and wood business was spun-off in 2004, and the company changed its name to OfficeMax Incorporated. Neither before nor after the 2004 merger, however, was the company able to grow shareholder equity.

The 2003 acquisition loaded the OfficeMax balance sheet with goodwill and intangibles, which were subsequently written off in 2008. The $1.3B write-off represented the entire purchase price of the original OfficeMax! OfficeMax has further demonstrated an ability to decimate shareholder equity via corporate action: in 2008, in addition to the aforementioned $1.3B write-off, the company recorded a $735 impairment charge on a note guaranteed by Lehman Brothers, in the wake of the Lehman Brothers bankruptcy.

The growth of Staples has not been entirely organic either – Staples acquired Quill Corporation in 1998, bought the European mail order businesses of Guilbert SA in 2002, and acquired Corporate Express in 2008.

While the Quill acquisition diluted Staples shareholders by some 20%, and the Guilbert SA and Corporate Express acquisitions added close to $1B and $3B of goodwill and intangibles, respectively, to the balance sheet, neither has resulted in write-offs or significantly affected the company’s ability to generate returns. The median ROE is around 16%, and the median ROA is 7.3%.

Staples is under significant pressure due to the recession. Its Retail segment (about 40% of overall sales, and half the profits) was hit by a 2% year-on-year decline in same store sales. A similarly sized Delivery segment has grown sales at a modest 8% last year. And the faster growing (13% y-o-y) International segment remains relatively small (21% of sales and 7% of profits). Despite this challenging environment, Staples remained profitable and achieved a respectable ROE of 12.6%, giving hope that ROE will recover to its historic 16% level when conditions improve.

By comparison, the median ROA for OfficeMax is a meager 1.1%, and the ROA is close to zero.

Throughout OfficeMax history, years of modest profits alternated with periods of losses. Keeping this long-term perspective will protect investors from extrapolating a good year or two into future earnings growth.

Compare this with the consistent earnings history of Staples:

We believe that Staples is attractively priced at a historically low price to book ratio of 2.4. Given its healthy balance sheet and limited growth opportunities, we would like the company to continue its share repurchases, suspended after the Corporate Express acquisition.

Examining long-term fundamentals of companies such as SPLS and OMX, and considering their long-term records in handling shareholder equity, is critically important for investors who want to select the winning investment in a particular industry, or make long-short pair investments. Staples and OfficeMax make for one such potential long-short pair, as do Walgreens (WAG) and CVS Caremark (CVS) – two companies we compared in a previous article. At, you can find a wealth of long-term analytical charts and data covering over 15 years of corporate fundamentals, including all charts and corporate events mentioned in this article. Registration is free.

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