In a rare shift for Staples, the chatter over the weekend surrounding the stock was actually positive. Credit Suisse upgraded the stock on the back of the depressed valuation as well as the possibility for further consolidation in the industry, such as SPLS buying ODP (personally, I view that as unlikely, but I’ll take the positive move today anyways).
Barron’s this weekend had an interview Richard Pzena, who mentioned the bull case for Staples revolving around the corporate and online businesses, which I discussed in the original trade idea.
Our plan on our SPLS trade all along was to wait for a spike back to near the pre-earnings high near $13 in May:
While I do think the downside in SPLS is still quite limited, I’m not terribly confident about significant upside in the near-term above $13, so I’m going to sell the call on today’s pop for a double vs. my initial entry.
Action: SPLS ($12.78) Sold Jan15 12 Call at $1.20 for a $0.61 gain
Staples is one of the few left-for-dead stocks of the past 5 years, amidst a general market rally that has lifted almost all boats. The stock is trading near a 10 year low after a bad earnings report in May, indicating that management’s restructuring plan was going poorly:
The company’s earnings report particularly disappointed on margins, as sales were actually in line. GS research outlined the problems at Staples in a downgrade of the stock in late May, with the following thoughts:
The office products sector continues to suffer from twin secular challenges – erosion in paper consumption weighing on sales of core office supplies (Exhibits 1 & 2), and encroachment from ecommerce weighing on both market share and margins vis-à-vis the retail business.
The sector’s two remaining firms, ODP and SPLS, are clearly working to do something about it, cutting stores and cutting costs. Both should benefit from restructuring activity, the closing of less profitable stores, and the associated sales recapture.
That said, we believe that ODP, coming off a lower base and with more dramatic cost opportunity, is likely to deliver upside to current Street forecasts, while SPLS, coming off a higher base, is likely to deliver on, but not exceed, Street estimates, as investments defray the benefits of cost reductions and sector consolidation.
The analyst goes on to note that SPLS operating margins are already at 4.5%, substantially higher than the expectations for ODP to reach 3% margins next year. Moreover, SPLS is reinvesting in its business to beef up its website arm given increased share online and competition from sites like AMZN. At the same time, Staples management is diversifying its product offering away from just office supplies, and into more general consumer merchandise. In short, the company is scrambling to maintain sales and various lifelines in a rapidly contracting market backdrop.
No surprise then that SPLS stock is near a 10 year low in price. However, the pessimism surrounding the stock has certainly reached a fever pitch. The stock is trading at only 1.17x book value, in distressed territory for a retailer that is cash flow positive:
There are other retailers, like JCP, that trade near book value, but JCP is a much more distressed situation than SPLS, with a much higher debt load and more future cash flow risk. The maturity of much of Staples’ liabilities is 2018 and 2023, as outlined in the company’s filing:
The Company has various other lines of credit under which it may borrow a maximum of $160.5 million. At May 3, 2014, the Company had outstanding borrowings of $100.2 million and outstanding letters of credit of $0.2 million related to these lines of credit, leaving $60.1 million of available credit at that date.The major components of the Company’s outstanding debt as of May 3, 2014 and February 1, 2014 are as follows (in thousands):
May 3, 2014 February 1, 2014 January 2018 Notes 498,988 498,919 January 2023 Notes 499,164 499,140 Commercial Paper 75,000 — Other lines of credit 100,239 100,100 Capital lease obligations and other notes payable 25,778 6,028 1,199,169 1,104,187 Less: current portion (182,272 ) (103,982 ) Net long-term debt $ 1,016,897 $ 1,000,205
TRADE: SPLS ($11.23) Bought Jan15 12 Call for $0.59
Break-Even on Jan15 Expiration:
Profits: above 12.59
Losses: up to 0.59 between 12 and 12.59, max loss of 0.59 below 12
Rationale: The low level of overall premium, and the fact that SPLS is near the $10.50 support level, led us to pull the trigger on this trade. The stock started the year near $16, and is retesting its lows of the year on the recent selling. Since there are more than 6 months until expiration, that offers plenty of time to capture at least one major rally in SPLS in that period, with our risk limited compared to a long stock position.