How are Office Supply Stores Surviving?

The greatest mystery in today’s retail landscape is how certain brands are surviving the Retail Apocalypse? An excellent example of this phenomenon is Office Depot (NASDAQ: ODP) and Staples (NASDAQ: SPLS).

The two office supply stores are limping along despite intense competition from Amazon (NASDAQ: AMZN), Costco Wholesale (NASDAQ: COST), Walmart (NYSE: WMT) and others. They somehow survive even as Amazon steals their business market and Walmart and Costco often dramatically undercut their prices.

Nothing not declining revenues, anemic incomes or the Federal Trade Commission’s (FTC) decision to kill the Office Depot and Staples merger seems to be able to kill these retailers. Naturally that will make some investors wonder if brick and mortar office supply is a good contrarian play for the Amazon economy.

Losses have slowed but Not Stopped

There are some good contrarian arguments for Office Depot and Staples. Both chains are maintaining respectable revenues and making amounts of money.

A Staples truck delivers office supplies in San Diego, California September 24, 2013. REUTERS/Mike Blake

Office Depot reported steady but slowly declining revenues on March 31, 2017. It recorded $11.46 billion in revenues on that day down slightly from $11.66 billion at the end of 2016 and $12.13 billion a year earlier. Staples reported revenues of $17.30 billion April 30, 2017, down slightly from $17.51 billion in January and $17.97 billion in April 2016.

The revenue figures indicate that the chains have been able to contain and minimize their losses but not stop them. The business is slowly disappearing but office suppliers are managing to hold their own. This is being done by closing stores and selling off foreign and other assets, a strategy that some other brick and mortar retailers ought to consider.

Are Office Depot and Staples Making Money?

Office Depot delivered in an interesting surprise in income, it is actually money. Office Depot reported a net income of $599 million on March 31, 2017, that marked a huge increase over March 2016 when Office Depot reported a net income of $9 million.

Office Depot is making money again which indicates that it might survive. Office Depot also has a little float in the form of $744 million in in cash and short-term investments, $647 million in cash from operations, and $5.435 billion in assets at the end of first quarter 2017. Its cash was still limited Office Depot reported a free cash flow of $58 million.

Is Staples in the Death Spiral?

Office Depot at least has stopped hemorrhaging money but Staples has not. Staples reported a loss of -$2.354 billion on April 30, 3017. That was a sudden drop from a net income of $361 million just a year earlier. This might indicate that Staples is in the death spiral.

The dramatic loss occurred despite $916 million in cash from operations, $1.29 billion in cash and short-term investments, a free cash flow of $221 million and $7.51 billion in assets at Staples. It sure looks as if Staples can no longer sustain its operations which might mean the end is in sight at that chain.

These numbers indicate that there’s a strong possibility that stables will be liquidated or sold in the near future. My guess is that we might see a sudden surprise sale of Staples; much like the acquisition of Roundy’s (a Wisconsin supermarket operator) by Kroger, Walgreens’ (NASDAQ: WBA) attempts to buy Rite Aid or Amazon’s Whole Foods coup.

Why Staples and Office Depot are Acquisition Targets

Staples is definitely an acquisition target because its purchaser would get around 1,225 stores and $17.30 billion in revenues for a low price. Staples reported a stock value of $10.10 a share, a market cap of $6.597 billion and an enterprise value of $6.597 billion on June 29, 2017.

The company also has excellent relationships with tens of thousands of businesses, local delivery networks of vans and hundreds of shipping locations. All of which still have a lot of value in today’s interconnected economy.

Office Depot is also something of a bargain with a footprint of around 1,100 Office Depot and Office Max stores in North America. Like Staples it has strong relationships with business and government customers, delivery capabilities and a respectable online presence. Despite all that Office reported a market capitalization of $2.914 billion, an enterprise value of $3.348 billion and a share value of $5.64 on June 29, 2017.

Why Amazon Might Buy Staples or Office Depot

That brings us to the all-important question of who would buy Staples or Office Depot? The most logical candidate right now is Amazon; which is trying to pump up its brick and mortar footprint fast to counter an aggressive push into online retail by Walmart.

Amazon needs more warehouse space; Office Depot or Staples, can supply that. It also wants to expand its local delivery capacity; Office Depot and Staples existing delivery capabilities can certainly do that. Amazon would also like to open hundreds or thousands of locations where customers can pick up orders or drop off returns. Office Depot and Staples stores; which already serve as drop off locations for packages, can certainly provide that capability.

Another advantage is that Staples or Office Depot can serve as service centers for electronics and other devices ordered through Amazon. Beyond that the stores can serve as places where customers can make cash payments to Amazon or pickup cash orders.

A longer term use for the stores would be as local hubs for delivery services offered through an Amazon app or Uber. That would allow Amazon to expand its local delivery capability without too much reliance on UPS or FedEx. Instead of using those services Amazon trucks would drop an order off at the neighborhood Staples where a driver would pick it up and take it to the customer.

All this makes an attempt by Amazon; or perhaps Alibaba Holdings (NYSE: BABA), to buy one or both of the office supply stores likely. All that remains to be seen is whether the FTC would approve such an acquisition. Office supply stores might very well survive as part of Amazon or another online retail giant.