Office Depot Analysis

Office Depot (Ticker: OPD), herein also referred to as “The Company,” is a global supplier of office products and servicesi. The company competes in the retail specialty industry, particularly in office products retail and distribution. Because of a decline in company financial performance, a fierce competitive landscape, and macro economic challenges for the retail industry overall, Office Depot is not a very attractive stock to buy at the current moment. Office Depot is a diversified business that sells many different products for the office products retail industry.The company sells everything from tiny paper clips to large office supply furniture.

The company sells these products through multiple channels that include large retail stores, a contract sales force, internet sites, direct marketing catalogues, and call centers. All of these has channels has led Office Depot to become the world’s number two office supply chain, behind only Staples Inc. The company operates more than 1,200 stores throughout North America and another 150 locations internationallyii.The company sells many established brands of office supplies such as Viking Office Products, NiceDay, Foray, and Ativa, as well as its own brand called Office Depot. Office Depot’s main strategy is to target small to medium sized businesses through its retail locationsiii. This is shown by the aggressive growth by opening 115 new stores in North America alone in 2006, while only closing 4, and which has accounted for 45% of its revenue. However since the US economy slowdown in the past year the company has only been able to open up 71 stores, while closing 7.

To counter-act this slowdown, Office Depot has aggressively expanded internationally into 40-plus countries, opening 26 stores, while only closing 3, in 2007. The other major source of revenue, about 30% comes from the business solutions division, which includes catalogue sales, online sales, and contract sales. The company breaks down its sales in 3 different categories including supplies, technology and furniture, which account for 63. 2%, 26. 0%, and 10. 8% accordingly in 2007Although sales have still grown over the past few years, Office Depot has had some trouble with their financial accounting. In 2007 Office Depot had to restate their financials due to a whistleblower’s complaint. The impact of the errors was a reduction in gross profit and a reduction in earnings per share by $4.

02. After the restatement in financials Deloitte and Touche gave Office Depot an unqualified opinion. However management is still worried about future growth prospects due to higher fuel prices and a softening of consumer spending.

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These factors are all important in analyzing a retail specialty firm. The retail specialty industry is a massive industry that contains a variety of sub industries from anything from Electronic Appliances to Pet supplies and represents $2. 01 trillion of sales in the first six months of 2008 in the United Statesiv. The specialty retail industry acts as a “category killer” where large superstores chains specialize in a niche market, such as office supplies, auto equipment, or electronics. The office products alone represented $332 billion in sales in 2006.However due to the current economic financial crisis, rising unemployment rates, and inflationary pressures many consumers and business’ are not spending as much on retail and office products. To combat this alarming trend, many of the office suppliers are expanding overseas to capture new markets and countries with growing gross domestic income, particularly China and India. For example, Office Depot has expanded into 40 plus countries, while rival Staples has acquired many international office retailers to grow their presence in countries, such as Argentina and Taiwan.

In addition, office retail suppliers are trying to differentiate themselves by not just selling products, but selling services as well to attract a wider customer base. For example, Office Depot has partnered up with Kodak to provide custom office promotional items, while rival Staples now offers in-store copy services so customers do not have to travel to a Copy Center such as FedEx Kinko’s as well. Both Office Depot and Staples also offer installation and delivery services to better serve the needs of their customers.Further, office suppliers are increasing their own private brands, which provide a higher profit margin than 3rd-party vendors. Both Office Depot and Staples offer over 2,000 office products under their brand names. Finally, online sales are continuing to grow and becoming a large driving factor in the industry. Online US Sales in the retail industry are expected to grow to 148 billion in 2008 up from 127.

3 billion in 2007. These trends have not only led to major changes in the industry, but also how investors analyze a retail specialty company.There are a number of key ratios which indicate the health of the retail specialty industry and office products subset. The first key ratio is the Real Growth in Gross Domestic Product. This measures the overall health of the economy of a particular country. If there is two consecutive quarters of decreasing GDP than that signals a recession and bodes poorly for office product sales. Another measurement is consumer confidence which poles 5,000 households on how they feel about the economy.

This is an important gauge for retail companies because it dictates how they should go about expanding or contracting their company. In addition the Department of Commerce and individual research firms also measures retail sales for particular industries. This helps to gauge how one particular industry within retail is performing, however many retail sales are seasonal, so this data can be somewhat skewed. Finally the consumer price index (CPI) measures inflationary pressures of consumer goods.If the core inflation rises too much than consumers will be less likely to buy goods. There are both qualitative and quantitative measurements that need to be addressed when analyzing a retail specialty company.

The overall business strategy needs to looked at and compared to competitors in particular subsets. This includes looking at where the stores are located, target market, concept and format, merchandising and store presentation, and technology. In addition management expertise needs to be looked at to see how the group operates the company.From a quantitative end there are several elements from the income statement, balance sheet and cash flow statement that need to be addressed. From the income statement Sales, Gross Profit Margin, and Operating Income measure how effective the company is growing and how efficient the company is operating. The statement of cash flows measures how liquid a retailer is to pay back debt or fend off emergency situations. Finally from the balance sheet inventory is the main figure to measure the speed in which a retailer can turnover its inventory.

All of these factors are important to measuring how any retail specialty firm including Office Depot performs against its competitors. Office Depot has many strengths along with a considerable number of weaknesses compared to its competitors. As mentioned before Office Depot has a large number of stores that allows it to reach a large number of customers. Because Office Depot can reach a number of customers, they have the ability to generate high sales revenue.This has allowed Office Depot to expand internationally and also allows for the acquisition of other office retailers to continually grow their core business. In 2006, Office Depot acquired Allied Office Products, which was the largest independent dealer of office product in the United States. This helped Office Depot shore up its Northeastern position as well as bring in a number of new customers from the healthcare and legal industries. Even though Office Depot has large strengths in purchasing power, the company also has a number of weaknesses.

The most blaring weakness was the shoddy accounting practices that led the company to restate financials. This has led to a drop in investor confidence as the share price has been reduced by 75% over the past 2 years. In addition there is shaky management trust as the Board tried to outs the current chairmen and CEO Steve Odland. Finally, even though Office Depot is the second leading office retail supplier, they are far behind the leading company Staples, who has over 2,000 stores in the United States alone and generates over $4 billion more in sales revenue.Office Depot also faces a number of opportunities as well as a number of threats. The opportunities mainly arise from their acquisitions and partnering with other firms.

Office Depot has recently partnered with Google to roll out a Business Resource Center that links all of Google’s applications, such as AdWords and GoogleMaps with the company’s office services. This will help Office Depot become a one-stop shop for all of a small business resources and helps Office Depot self differentiate itself from it’s competitors.This will be key to Office Depot’s growth because the higher-margin commercial segment at 36% is likely to outpace the retail segment at 64% over the next few years. Even though there is expected growth in the commercial sector, there are also a number of risks to Office Depot current model that could effect future growth. The major threat comes from competition. The office retail market is already a very mature market with only a predicted 3% growth rate for the next couple of years, which means there will be a lot of competition for business.

Staples Inc. is already a cost leader in the industry and has a number of more stores than Office Depot. In addition Staples Inc. is seen as first mover while Office Depot is usually a step behind in emulating Staple’s strategy.

For example, Staples was the first to roll out with a business solutions center, while Office Depot was months behind. In addition Staples moved first to create smaller more focused stores and only in 2008 is Office Depot come out with their M2 plan store design which focuses on cost efficient construction and product placement.In addition there are a number of smaller local stores that are specializing in one type of business solution, such as ink cartridge refills, which further take away from Office Depot’s market base. Other risks and threats include uncertain activity in the international market, execution of expansion plans, cannibalization of sales from existing Office Depot stores, labor costs, and new systems and technology that could make current Office Depot inventory obsolete. When analyzing the financial performance of Office Depot it is important to look at a number of key ratios and how they have changed over the past few years.

There are four different categories of ratios (liquidity, profitability, activity, and coverage) which can be seen on Exhibit 1. The most important measure of a firm’s liquidity, that is how well a firm can meet it’s short term obligations, is working capital. This is current assets minus current liabilities. As shown from 2006 to 2007, Office Depot’s working capital has increased from 462 million to 742 million. This is probably due to the decreased expansion from 2006 to 2007. Office Depot’s efficiency is further shown in profitability ratios.Return on Assets, Profit Margin, and Return on Equity have decreased in 2007 to 5. 7%, 2.

54% and 13. 92% respectively. These are all down from 2006 which shows that the company was not as profitable as a year before, probably due to high expansion from the year before with low overall growth in the market. This is also proven in the coverage ratios, which measure the company’s ability to meet all debt. This is mostly shown in the debt to assets and debt to equity ratios that have increased to 11% and 27% respectively.This means the company is issuing more debt than there assets and equity stake of their shareholders. Finally the activity ratios are important to measure a firm’s inventory. Office Depot’s Inventory Turnover has decreased to 2.

24 while days in inventory have increased to 53. 92. This shows that Office Depot is not as efficient in relieving itself of its inventory. It is also important to perform a vertical analysis of the balance sheet and income statement to help understand financial performance over the years.The balance sheet measures every item against net sales. These important measurements when compared to previous years.

As seen on Exhibit 2 there have not been too many drastic changes, however it is important to note that from 2005 to 2007 Total Current Assets have dropped 7% against sales. This might be an indicator that the company as not as liquid as it was in previous years. However Office Depot has also done a decent job in counteracting that with their current liabilities as this has dropped from 2006 to 2007.When performing a vertical analysis against the income statement it is important to measure every line item against net revenue. Exhibit 3 also shows that the income statement has been fairly steady over the past few years. There has been a slight 2% rise in costs of good sold, which has led to a 2% decrease in profit margin. This could be from inflationary factors discussed earlier or from Office Depot not being able to turn over its inventory as quickly. It is also important to perform a horizontal analysis against Office Depot’s main competitor which is Staples.

As seen in Exhibit 4 of Staples consolidated balance sheet, Staples has a considerable amount more of total assets at 9 billion, compared to Office Depot’s 7 billionv. Further total current liabilities in 2007 are less for Staples at 2. 6 billion compared to Office Depot’s nearly 3 billion. On the income statement seen in Exhibit 6, Staples generated 19 billion in sales for 2007 while Office Depot generated 15. 5 billion in sales. More importantly Staples had a wider profit margin of 5.

5 billion while Office Depot only had a profit margin of 4. billion. This all shows that Staples is more efficient at allocating their resources and generating revenue compared to Office Depot. This is further proved in a ratio analysis of the two companies. Staples Ratios can be seen in Exhibit 7.

Staples had a Return on Assets of 12% in 2007 which is nearly double that of Office Depot. Further the Return on Equity for Staples is nearly 21% in 2007 compared to only 14% for Office Depot. Therefore Office Depot has not been earning as much profit compared to the amount of shareholder equity that is issued.Office Depot faces considerable challenges in the next year which make the stock not a very attractive buy at the moment. However the stock has suffered a 75% drop in the past 2 years and currently sits at $2. 85, which is at a very low Price to Earnings ratio of 3.

84vi. It is important to remember that Office Depot is still the number 2 office product supplier and although liquidity has gone down, and has plenty of hard assets to ensure survival. Therefore the recommendation is not to buy, but to Hold if Office Depot stock is currently possessed.