Office supply giant Staples (click ticker for report: ) reported a sharp decline in its second quarter results. Revenue fell 6.6% year-over-year to $5.5 billion, slightly worse than the Street expected. Earnings tumbled 25% to $0.18 per share compared to consensus expectations that called for a much smaller decline. The firm also slashed its fiscal year 2012 revenue outlook to flat revenue growth from low-single-digit expansion. Additionally, the company reduced its full-year earnings outlook to low-single-digit growth (was high single digits), despite an additional operating week during the year.
Europe was notably weaker than North America, as same-store sales fell 9% and total international sales dropped 18% (10% in constant currencies). The firm pointed to slow computer sales, as well as general economic weakness as the main factors behind the region’s poor performance. Though we think macro weakness certainly impacted Staples’ results, we believe some of the weakness can be attributed to the secular decline of the firm’s business model. North American same-store sales fell 2% due to a comparable decline in traffic. Office supplies are a commodity business, and demand for various items such as pens and paper is likely to fall over the long run. Several other businesses like Amazon (click ticker for report: ) and Costco (click ticker for report: ) are able to provide the same products at a lower price.
Though Staples predicts it will generate $1 billion in free cash flow during fiscal year 2012, we aren’t enamored with Staples’ business model. Staples successfully displaced competitors like Office Depot (click ticker for report: ) over the past several years, but its commodity-product business lines simply aren’t that attractive. That said, Office Depot, which doesn’t boast the same level of service or fulfillment capabilities, will likely continue to lose share, perhaps leaving Staples as the main brick-and-mortar player in the office supply industry in coming years.
However, competition from everyone, ranging from Walmart (click ticker for report: ), Target (click ticker for report: ) and Costco to Amazon and Best Buy (click ticker for report: ) could negatively impact margins going forward. Consequently, we aren’t interested in the firm at current levels, as shares score just a 3 on our Valuentum Buying Index (our stock-selection methodology). We think shares are fairly valued and would require a much larger margin of safety before getting excited about the name.