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Office Depot Loses Neutral Tag

Zacks Equity Research

Following a dismal first-quarter 2012 top-line performance, we recently downgraded our long-term recommendation on Office Depot Inc. (ODP) to Underperform with a price target of $2.00. Earlier, Office Depot had been enjoying a Neutral rating.

Office Depot’s total revenue of $2,872.8 million fell short of the Zacks Consensus Estimate of $2,884 million, and decreased approximately 3% on a year-over-year basis. Management had earlier predicted sales to decline between 3% and 4%. However, the quarterly earnings came in at 5 cents a share, in line with the Zacks Consensus Estimate, and marked a sharp increase from a break even in the year-ago quarter.

We believe that the change in the demand for office supplies products and services remains one of the indicators that describe the health of the economy. The economy is still not out of the woods, and amidst such a scenario Office Depot has to walk the tight rope to juggle with unprecedented situation that may hurt its growth prospects.

The underperformance can be traced back to North American Retail and International divisions, where sales were down 8% and 2%, respectively. However, North American Business Solutions division acted as a savior to some extent, with sales rising 3%.

We remain cautious about the macroeconomic environment and sluggish job market. The recovery in the economy is murky. As a result, consumers and small businesses still remain watchful about their spending for big-ticket items such as business machines and other durable products. We observe that the demand for office products is closely tied to the health of the economy.

Management now expects total sales for the second quarter of 2012 to decline 3% from the year-ago quarter, and further hinted that adjusted operating income is expected to decline $20 million to $30 million. Further, Office Depot forecasted that North American Retail division’s comparable-store sales would decline in the second quarter, and hinted that International division’s sales would fall 4% to 5% in constant currency.

Moreover, due to high exposure to international markets, Office Depot 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 the U.S. An increase in price may have an adverse impact on the demand for the products.

Let’s Conclude

No one can predict the future but genuine efforts are implemented to combat the tough economy. Business budget remains tight, consumers remain cautious than ever before and companies are trying hard to navigate through the challenging maze. Office Depot, which competes with OfficeMax Inc. (OMX) and Staples Inc. (SPLS), holds a Zacks #3 Rank that translates into a short-term “Hold” rating.

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