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Why Office Depot Has Turnaround Potential

Following its 30% stock price decline in the last year, Office Depot Inc. (NASDAQ:ODP) could offer strong recovery prospects.

The stationery and office supplies retailer is making changes to its stores, engaging in an acquisition program and investing in new product categories to increase the size of its potential customer base.

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Investing for growth

The company is increasing its presence in product categories that are adjacent to its core segments, which should provide it with cross-selling opportunities areas that are highly fragmented. For example, in the second quarter, Office Depot recorded a 10% sales increase in its non-core Cleaning & Breakroom product category. It is a $26 billion industry where the company could gain market share through leveraging its core customer base.

Office Depot is seeking to make acquisitions in markets where it currently has no presence. It has made 11 acquisitions since it began pursuing this strategy, which has increased the size of its total addressable market. This could provide the company with additional cross-selling opportunities that boost its sales and margins.

Store changes

The company plans to close its unprofitable stores over the medium term. This should improve its financial performance as well as allow the business to focus on its most successful segments.

In addition, the retailer is utilizing its stores as community connection points for local schools and businesses. To facilitate this, Office Depot is growing its number of partnerships with small business associations and chambers of commerce that utilize its stores for their events. This could increase the company's customer loyalty levels, as well as provide further sales opportunities for the business among consumers with whom it may not have an existing direct relationship.

Office Depot launched its first two store-within-a-stores with Lenovo in the second quarter. The new stores seek to provide consumers with an innovative experience that encourages a greater exploration of the products Office Depot sells. This could boost the company's customer engagement levels and allow it to achieve a higher sales conversion rate.

The company's continued partnership with Telos ID to provide identity verification services within its stores could lead to additional traffic. This may provide Office Depot with sales opportunities among new customers, as it plans to increase the availability of the service from 200 stores to 500 stores by the end of the current fiscal year.

Potential threats

The company's recent financial performance has been disappointing. For example, its revenue declined 2% in the second quarter from a year ago. This was largely due to a 7% drop in sales in the company's CompuCom division, as well as a 5% decrease in sales in Office Depot's retail division.

The performance of CompuCom has improved following its very poor start to the year. For example, its operating income increased $1 million in the second quarter compared to a $15 million decline in the first quarter. CompuCom could catalyze Office Depot's long-term financial prospects due to its differentiated offering. It may help to reposition the wider business so that it can develop partnerships that would otherwise not be possible.

In addition, Office Depot has made changes to CompuCom's management team as it seeks to capitalize on its core products and increase its exposure to new markets. It is also seeking to improve the division's efficiency as part of a group-wide initiative that aims to generate at least $40 million in cost savings in the current fiscal year.

Outlook

Analysts forecast that Office Depot's earnings per share will be 36 cents in fiscal 2019 and remain at the same level in fiscal 2020. Despite its lack of near-term growth potential, the stock's forward price-earnings ratio of 5.5 suggests it has investment appeal.

Disclosure: The author has no positions in any stocks mentioned.

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This article first appeared on GuruFocus.