Office Depot (ODP) has been making great strides over the last year to execute a transformation strategy to become a more service and technology oriented company. As the CEO Gerry Smith said after acquiring CompuCom in 2017, “Technology is theoffice supply of the future” and the company has certainly been putting its money where its mouth is. ODP paid over 1 billion dollars for the acquisition and has beencontinuously investingin their supply chain, eCommerce, services platform, and technology. The market had also taken notice after their FY2018 results, jumping from the low 2’s in December to highs of over 3.80.
This was short-lived, however, as Mr. Market was not pleased with the preliminary FY19 1st quarterresults. I will firstly go over the key takeaways from the FY18 results and why they lead me to be bullish. I will then examine the warnings in the preliminary results and illustrate if they take away from the long term thesis.
Via https://newsapi.org online business online marketing online business opportunities FY18 Highlights
Some of the highlights from FY18 results were that annual sales increased 11% to $11 billion, service sales grew 84%, and there was $567 million EBITDA. Given the market cap of just under $1.5 billion right now, the company generated a high level of income. The company’s FY19 guidance was ~$575 million in EDITDA and ~11.1 billion in sales. Though growth in the near-term is modest, for the current price, there is amazing value to be had here. The most noteworthy point is that the company’s expenditures are not just to keep the stores afloat; these are investments to better attract and retain customers to ODP’s service offerings.
However, at the current valuation, the market is pricing the company as though there will be no growth or even a decline in earnings. This is simply not true, as the company generates a ridiculous amount of cash even with all the investments it is making while paying off debt. As of the last earnings report, the company has $658 million in cash, even higher than the prior year’s end at $622 million. The long-term debt load is $690 million vs $926 million the earlier year. To top it off, the company has under a 7 forward PE. At a stock price of $2.50, the dividend is 4%. The company also has a buyback in place that can benefit from the recent decline in price.
There is one statistic that at first glance might warrant concern, which is the “$754 million of non-recourse debt supported by the Timber Notes receivable” that management excluded from the debt total. Digging intotheir last 10-K, it appears these are remnants from the merger with Office Max quite some time ago. The main takeaway from Note 7 in the document is that the Securitization notes are indeed more than covered by Timber Notes which are listed as $842 million. We can take management’s word at face value that this debt can be disregarded, particularly because it is non-recourse and does not jeopardize other company assets.
Via https://newsapi.org online business online marketing online business opportunities Preliminary Results Disastrous or Just a Blip?
Now we know the stock is cheap given the last earnings call, but what about thepreliminary 1st quarter results? What stands out most are the operational issues at CompuCom, running a 15 million dollar loss for the quarter due to lower than expected revenue from customer projects and higher expenses for developing and marketing new business services. The company plans to streamline processes, reorganize the customer facing org, and realign sales to improve long term profitability. While this news does affect short-term profitability of the CompuCom division, it has no bearing on the long term prospects of Office Depot. Considering the company’s estimated forward EBITDA of $575 million, a small loss for CompuCom is a drop in the bucket for the company. Anyone investing in Office Depot currently should do so for the long term, as there will undoubtably be bumps along the way when a large company is trying to drastically change its business model. If the service offerings has muted growth or declines for at least a year’s stretch, then there may be a reason to worry.
Via https://newsapi.org online business online marketing online business opportunities Moving Into Co-working Spaces
Another point that stood out to me that market seems to have ignored are the additional initiatives it is taking on aside from CompuCom. The co-working opportunities in particular caught my eye, so I decided to dig a little deeper into the economics of this industry and the company’s progress on this venture. For those unfamiliar with the concept,co-working spacesallow individuals and businesses to rent office space for time intervals that are more flexible than traditional office leases. If a certain type of worker only needs an office space in the morning, or only on certain days of the week, a co-working space makes far more sense economically than renting out a whole office floor on a yearly basis. The operator can than charge higher rates for part-time occupancy, as the clients are still individually saving money compared to renting the space full-time. With the rise of hot startups like WeWork, which was valued ashigh as $47 billionwith its last round of funding despite having under $2 billion in revenue and operating at a loss, the private market is definitely seeing a future for co-working spaces.
Source:Office Depot website
But how is Office Depot faring in this venture? The company launched itsfirst co-working spacein Los Gatos, California last August and has since opened 4 more spaces, the latest in Dallas and Chicago. These Workonomy Hubs are another step the company is taking to provide broader business services and solutions to customers. The offerings in each hub are comprehensive, with different types of memberships to cater to everyone from lone individuals to teams needed conference rooms to collaborate. Office Depot can also cross-sell many of its business services, like copying/printing, tech support, and mail/package handling. What ultimately matters though is the impact on Office Depot’s bottom line, and with only 5 locations, this is still an early initiative. However, should this prove a successful concept, it will provide a way for Office Depot to further monetize extra space in stores as it moves away from its retail operations. Unlike a pure-play co-working business, Office Depot does not need to acquire new leases to grow, as it already has an large fleet of stores that it can take advantage of.
Another interesting recent development is Office Depot’scollaboration with Alibaba(BABA). From the release, the two companies have launched “a new co-branded online destination, “Office Depot on Alibaba.com”: Office Depot and Alibaba.com have launched a new online destination,www.alibaba.com/officedepot, that provides U.S. SMBs access to Alibaba.com’s global supplier network, offering a wide product selection, as well as exclusive online and in-store offers for some of Office Depot’s best-in-class products and services.” An investigation into the significance of this partnership may warrant another article, but on the surface, this does serve as a way for Office Depot to compete with the likes of Amazon (AMZN) more effectively.
Via https://newsapi.org online business online marketing online business opportunities Key Take-aways
Office Depot had excellent FY18 results and the company is continuing to transition into a business services and solutions company. While at first glance, it is easy to dismiss Office Depot as another retailer that will be marginalized by Amazon, the efforts the company is taking to pivot into new areas like co-working spaces will allow it to grow in the future. The cherry on top is that after the preliminary results, an excellent entry point has presented itself for long-term GARP investors.
Disclosure:I am/we are long ODP.I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.