Are Office Supply Stores Doomed?

Are office supply stores doomed to go the way of television repair shops and the neighborhood garage? Judging by the financial numbers and stock prices at Office Depot (NASDAQ: ODP) and Staples (NASDAQ: SPLS), they are.

The two remaining national office supply chains are in very sorry shape right now. On January 22, 2016, Office Depot was trading at $5.07 a share even though it reported a TTM revenue of $14.84 billion on September 30, 2015. Meanwhile, Staples was trading at $8.91 a share on the same day even though it had revenues of $21.45 billion on October 31, 2015.

Those revenues look good until you take a look at the charts. The charts clearly show us that sales and revenues at brick-and-mortar office supply stores are declining dramatically. Staples had revenues of $24.19 billion in October 2012 that fell to $23.81 billion in October 2013, $22.71 billion in October 2014 and $21.45 billion in October 2015.

Office Depot did a little better because it merged with the third major player in the business, Office Max, a couple of years back. Office Depot reported a TTM revenue of $11.04 billion in September 2012 that shrank to $10.38 billion in September 2013, rose to $15.75 billion in September 2014 after the Office Max merger and fell to $14.84 billion in October 2015.

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How Amazon.com Is Killing Brick-and-Mortar Office Supply Stores

The revenue figures clearly show us that the office supply market is steadily declining. They do not tell us why the decline is happening, but anybody that has shopped for office supplies online lately can tell you who is taking Office Depot and Office Max’s market share: Amazon.com Inc. (NASDAQ: AMZN).

Last week I needed to buy some envelopes to ship books in for my part-time business. I went to Amazon.com and found 100 of them selling for around $19.00, or 19¢ apiece, with free shipping. I had been paying around 32¢ apiece for a similar product from Sam’s Club; Staples was selling a comparable mailer for 86¢ apiece, or $6.89 for an eight pack. Office Depot’s mailing envelopes were selling at 80¢ apiece, or 25 for $19.99. As a business person who needs to control expenses, I cannot afford to pay those prices or to shop at Office Depot or Staples.

 

From my experience, it is clear that both Office Depot and Staples are no longer capable of countering Amazon’s prices. Instead, the Everything Store is now the place with the cheapest office supplies. Small businesspeople—who are the prime market for office supplies—understand that clearly even if Staples and Office Depot’s management teams do not.

The Amazon Effect at the Office Supply Store

Amazon’s effects can be clearly seen in the financial numbers. On September 30 Office Depot reported a net income of -$91 million, a profit margin of .16%, a return on equity of -5.56% and $121 million in cash from operations. The cash from operations figure at Office Depot should really concern us because it took a serious drop in 2015; in June 2015 Office Depot brought in $183 million in cash from operations but by September, just three months later, it had fallen to $121 million. That’s a loss of $62 million over a quarter.

An Office Depot location in Michigan

Staples suffered a similar drop; it reported $1.039 billion in cash from operations in July 2015 and $837.94 million in October 2015. That means Staples’ cash from operations declined by $200.106 million over third quarter 2015, although some of Staples’ other numbers were a little better than Office Depot’s; it reported a net income of $32.53 million, a profit margin of 3.54% and a return on equity of .6%.

These numbers make it clear that these companies’ business simply is not sustainable. A massive reorganization and store pruning will be necessary just to survive. Drastic action and a rethinking of the business model is needed, but that is not what is going on.

Why the Staples/Office Depot Merger Will Not Work

Unfortunately, there is no new thinking at either retailer; instead, management is answering investors’ concerns with that classic move of desperate and dying companies: merge with an ailing competitor. Staples had been trying to buy Office Depot for $6.3 billion, but the deal is apparently off because of objections from the Federal Trade Commission (FTC).

Strangely enough, the FTC’s objections might have done investors a favor because it is clear that the Staples/Office Depot deal will not work. Office Depot got a brief boost in revenue from its Office Max acquisition, but the financial numbers show us its revenue is falling again.

Therefore, any reprieve Staples would get from acquiring Office Depot would be temporary. That $6.3 billion would be better spent ramping up Staples’ ecommerce infrastructure to stave off Amazon.com and the growing threat from Walmart.com (NYSE: WMT).

On January 24, 2016, I found some bubble mailers at Walmart.com for 38¢ apiece. That’s much more expensive than Amazon, but given Walmart’s obsession with low prices, I imagine that price will soon come down.

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My prediction here is that Office Depot and Staples will continue their trip down the death spiral unless somebody buys up one of these companies. Both would be fairly cheap; Office Depot had a market cap of $5.735 billion on January 24, 2016, and Office Depot had a market capitalization of $2.782 billion on the same day. The logical company to acquire either of these would be an online retailer such as Alibaba (NYSE: BABA). The Staples or Office Depot.com brand names would be a tremendous asset for any online retailer.

One thing is clear though: The brick-and-mortar office supply business is doomed. My prediction is that both Office Depot and Staples will collapse within the next few years, whether or not they merge. Investors should stay away from this sector because it simply has no future.