Office Depot stocks in decline

Office Depot stocks are in serious trouble. Its hoped-for acquisition by rival Staples appears less and less likely, even as its business continues to be eroded by online retailers.

Office Depot shares rallied starting in late 2014 and early 2015, first on speculation about a merger and then on official confirmation of it. Staples said it would pay $7.25 in cash and 0.2188 of one of its own shares for each share of Office Depot.
Since then, the stock’s trajectory has been lower because of concerns the deal wouldn’t pass regulatory muster. Over the past year, shares have lost 43%.

What lies ahead for Office Depot?

First let’s explore the merger in greater detail. Investors had poured into the stock hoping to receive a nice payout from the eventual Staples acquisition. But the Federal Trade Commission in December filed a lawsuit to stop the acquisition, and Staples’ challenges to regulators have already suffered at least one crucial setback.

And even though both companies recently agreed to sell some assets after their deal is completed in order to assuage regulators, the FTC hasn’t veered from its opposition. Now a March courtroom battle looms. The companies have extended the merger termination date to May 16 in order to give themselves enough time to try to win the legal fight, but investors shouldn’t hold their breath, given how firm the government opposition is.

Now let’s look at expectations for Office Depot’s coming earnings report and what they indicate about its underlying business.

Office Depot plans to report earnings for the quarter that ended 26 December 2015 on Tuesday 23 Febrauary. On average, analysts expect adjusted earnings per share to increase to 11 cents from 7 cents a year earlier, but revenue is expected to drop 7,2% to $3.56-billion.

Declining revenue is the trend, too. The company missed revenue expectations in all of the past four quarters. Analysts also expect sales to decline year over year in the current fiscal quarter and for all of fiscal 2016, which ends on 26 December this year.

The declining revenue appears to have two causes. First is store closures and other adjustments linked to the deal with Staples. Second is the challenge to traditional office supply retailers from online competitors – most notably Amazon.

When Staples announced the Office depot acquisition, it said that cost savings from the deal would total at least $1-billion by the third full fiscal year after the deal closed. It’s true that a combined company (which we’ve noted appears more and more unlikely anyway) would benefit from lower costs and a smaller retail footprint, but the real problem is sales stagnation for both of these companies, combined or separate.

Reversing that stagnation requires that they refocus their efforts more on online sales. But even if they do that, success is by no means guaranteed, because Amazon is such a formidable competitor.

Investors should be very cautious about Office Depot stock at this time. Don’t be fooled by the forward price-to-earnings ratio of less than 10. This stock is cheap for good reason.

By Chiradeep BasuMallick for www.thestreet.com

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