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Investors Should Not Give Up on Office Depot: Here's Why

Zacks Equity Research

Office Depot, Inc. ODP has undertaken a strategic review of its business operating model, growth prospects and cost structure to bring itself back on growth trajectory, after an attempt to merge with Staples, Inc. (SPLS) fell through. We noted that the shares of this office supplies retailer have surged roughly 39% in the past six months compared with the Zacks categorized Retail-Miscellaneous/Diversified industry that declined 3.2%. Further, the stock’s long-term earnings per share growth rate of 10.3% and a VGM Score of “A” portrays its inherent strength.

Hidden Catalyst

Office Depot is closing underperforming stores, reducing exposure to higher dollar-value inventory items, shuttering non-critical distribution facilities, concentrating on eCommerce platforms as well as focusing on providing innovative products and services. Moreover, the company is increasing its penetration into adjacent categories. The decision to sell its European operation gives a clear indication that the company wants to focus on its core North American market.

With respect to the cost containment effort, Office Depot is employing a more efficient customer coverage model, focusing on lowering indirect procurement costs along with general and administrative expenditures, and is also gaining from its U.S. retail store optimization plan. Management expects these endeavors to result in annual benefits of over $250 million by the end of 2018.

As part of its U.S. retail store optimization program launched in 2014, the company had shuttered 400 stores in the first phase, and plans to close 300 more stores in the second phase over the next three years. Further, it is focusing on smaller format stores of 15,000 square feet to better serve customers.

Hurdles to Overcome

Analysts pointed out that demand for office products (paper-based) has been decreasing due to technological advancements. Smartphones, tablets and laptops are fast emerging as viable substitutes for paper-based office supplies. Moreover, there has been persistent weakness in the office products sector. Further, stiff competition from online retailers such as Amazon.com, Inc. AMZN has been playing spoilsport for Office Depot. As per recent media report, Costco Wholesale Corporation COST and Wal-Mart Stores Inc. WMT are also striving to enter the office supply delivery services which will further intensify the competition.

The company continues to battle a dismal top-line that missed the Zacks Consensus Estimate for the ninth consecutive quarter, when it reported third-quarter 2016 results. Management expects total sales to be lower in fourth-quarter 2016 in comparison with the prior-year period, due to store closures, business disruption owing to merger related issues and tough market conditions. Additionally, the company now projects total sales to be lower in 2017 in comparison with 2016.

Office Depot currently carries a Zacks Rank #3 (Hold).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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