Office Depot Upgraded

Zacks Investment Research
updated | Zacks.com

Buoyed by better-than-expected second-quarter 2011 results, we recently upgraded our recommendation on Office Depot, Inc. (NYSE:ODP), the supplier of a range of office products and services across the globe, to Neutral with a price target of $3.25. Earlier, we had an Underperform rating on the stock.

The second quarter loss of 6 cents a share, not only improved from the prior-year quarter’s loss of 9 cents but also the Zacks Consensus Estimate of a loss of 12 cents. However, Office Depot’s total revenue of $2710.1 million fell short of the Zacks Consensus Estimate of $2,728.0 million, but increased marginally from the prior-year quarter’s revenue of $2699.5 million.

Office Depot is repositioning itself to keep afloat in a difficult consumer environment. The company is containing costs, closing underperforming stores, reducing exposure to higher dollar-value inventory items, shuttering non-critical distribution facilities, and focusing on providing innovative products and services, which should all contribute to margin improvements.

The company in order to enhance its global footprint has made strategic acquisitions over the past few years, and is still looking for accretive opportunities. Office Depot is reviewing capital-efficient opportunities to expand its reach in Eastern Europe, Asia and South America.

Office Depotin order to drive sales has undertaken initiatives, which includes, improvement in customer in-store shopping experience, investment in Copy & Print Depot and Tech Depot services, remodeling and introduction of smaller format stores, and margin improvements through rationalization of stock keeping units and product pricing. Management anticipates that these initiatives could result in $75 million to $100 million by way of annual benefits by the end of 2013 at North American Retail division.

However, we remain cautious about the current economic unrest after Standard & Poor’s downgraded the credit rating of the U.S. to AA+ from AAA. As the economy continues to be sluggish, consumers and small businesses remain frugal about big-ticket spending on items such as business machines and other durable products. Therefore, we believe that the demand for office products is closely tied to the health of the economy.

Moreover, due to high exposure to international markets, Office Depot remains prone to currency fluctuations. The weakening of foreign currencies against the U.S. dollar may require the company to either raise prices or contract profit margins in locations outside the U.S. An increase in price may have an adverse impact on the demand for the products.

Given the pros and cons, we prefer to be Neutral at this juncture. Moreover, Office Depot, which competes with Staples Inc. (NASDAQ:SPLS) and OfficeMax Inc. (NYSE:OMX), holds a Zacks #3 Rank, which translates into a short-term ‘Hold’ recommendation.

 
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