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Office Depot Has Surged Since Earnings, Can It Continue?

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At times it is rational to hold certain stocks that have enough potential but are weighed down by tough market conditions. These stocks rally as soon as the market enters into a correction mode. Here, we have discussed one such stock, Office Depot, Inc. (ODP - Free Report) with expected long-term earnings per share growth rate of 10.3% and a VGM Score of “A”.

We noted that the shares of this office supplies retailer have surged roughly 35% since its third-quarter 2016 earnings release. In the past three months, it has surged 33.5% compared with the Zacks categorized Retail-Miscellaneous/Diversified industry that has witnessed an increase of 8%. But if we look at the stock’s year-to-date performance, it reflects a bleak picture. So far in the year, the stock has declined approximately 16%. So, an obvious question arouses, whether the stock’s recent bullish run is sustainable?

 

 

Growth Drivers

After the termination of the merger with Staples, Inc. , Office Depot has undertaken a strategic review of its business operating model, growth prospects and cost structure. The company is closing underperforming stores, reducing exposure to higher dollar-value inventory items, shuttering non-critical distribution facilities, concentrating on eCommerce platforms as well as focusing on providing innovative products and services. Moreover, the company is increasing its penetration into adjacent categories. The decision to sell its European operation gives a clear indication that the company wants to focus on its core North American market.

With respect to the cost containment effort, Office Depot is employing a more efficient customer coverage model, focusing on lowering indirect procurement costs along with general and administrative expenditures, and also gaining from its U.S. retail store optimization plan. Management expects these endeavors to result in annual benefits of over $250 million by the end of 2018.

As part of its U.S. retail store optimization program launched in 2014, the company had shuttered 400 stores in the first phase, and plans to close 300 more stores over the next three year time frame in the second phase. It is also focusing on smaller format stores of 15,000 square feet to better serve customers.

Hurdles to Overcome

Analysts pointed out that demand for office products (paper-based) has been decreasing due to technological advancements. Smartphones, tablets and laptops are fast emerging as viable substitutes for paper-based office supplies. Moreover, there has been persistent weakness in the office products sector. Further, stiff competition from online retailers such as Amazon.com, Inc. (AMZN - Free Report) has been also playing spoilsport for Office Depot. As per recent media report, Costco Wholesale Corporation (COST - Free Report) and Wal-Mart Stores Inc. (WMT - Free Report) are also striving to enter the office supply delivery services which will further intensify the competition.

The company continues to battle a dismal top-line that missed the Zacks Consensus Estimate for the ninth consecutive quarter, when it reported third-quarter 2016 results. Management expects total sales to be lower in fourth-quarter 2016 in comparison with the prior-year period, on account of store closures, business disruption owing to merger related issues and tough market conditions. Additionally, the company now projects total sales to be lower in 2017 in comparison with 2016.

Office Depot currently carries a Zacks Rank #3 (Hold).

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