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Bearish View on Staples

Zacks Equity Research

Staples, Inc. (SPLS) seems to be in an unfavorable position as the unstable economic climate continues to weigh upon the performance of this beleaguered office products and services retailer, as evident from its dismal second-quarter 2012 results and trimmed outlook.

The company’s disappointing performance compelled us to take a bearish stance on the stock, and hence we downgrade our recommendation to Underperform with a price target of $10.50. Earlier, we had a Neutral view on the stock.

Staples posted sluggish second-quarter results. The quarterly earnings of 18 cents a share missed the Zacks Consensus Estimate of 22 cents and decreased 18% from the prior-year quarter due to lower-than-expected sales trends in North America and continuing softness in Europe and Australia. The company witnessed a sharp fall in computer sales and sluggish trends in core categories.

Staples, which competes with OfficeMax Inc. (OMX) and Office Depot Inc. (ODP), reported total sales of $5,498.5 million, down 6% year over year and well below the Zacks Consensus Estimate of $5,721 million. In constant currency, total revenue fell 3%. North American Delivery sales edged down 0.8%, North American Retail sales descended 2.7% and International sales plunged 18.2%.

Given the soft results, management lowered its earlier guidance and now expects sales for fiscal 2012 to remain flat compared with the prior year, while the bottom line is expected to increase in low single digits. Management had earlier forecasted sales to increase in the low single-digits, while the bottom line was projected to jump in the high single digits in fiscal 2012.

It is apparent that Staples is struggling both at the top and bottom lines. With the economy still witnessing uneven recovery, consumers and small businesses remain apprehensive about big-ticket spending such as business machines and other durables. Thus, the demand for office products is likely to remain slothful as the performance of this sector is correlated to the economy’s health.

Staples expects sluggish growth in the U.S. economy and hinted that demand will remain soft in Europe. With the European debt crisis yet to be fixed, Staples has a dull picture to portray as it suffered a 9% decline in its comparable-store sales in the region in the last reported quarter.

Due to high exposure to international markets, Staples remains prone to currency fluctuations. The weakening of foreign currencies against the U.S. dollar may require the company to either raise prices or contract profit margins in locations outside of the U.S. An increase in price may have an adverse impact on the demand for the products.

The above analysis supports our unbiased view, and advocates our bearish stand on the stock, which is well defined through our Zacks #5 Rank that translates into a short-term “Strong Sell” rating. However, the company has undertaken slew of measures, which are yet to show results.

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