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This week I’ve got a sell short on one of the world’s largest office products and furniture retailers . . . Office Depot. With the US markets last week grinding sideways to ending lower on Friday, I’m seeing a lot of weakness in the markets currently that are looking out like their running out of steam to move higher into even more resistance.

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Increasing volatility in stocks and commodities could continue to be the main theme in the week ahead as investors watch the latest U.S. economic reports for signs the recovery is moving forward or not. The European debt crisis is still a big focus also with the ECB heads of state meeting this week to discuss the debt problems of Greece, Portugal, and Ireland. The European finance ministers meet Tuesday, and the IMF, European Central Bank team spend the week in Athens. Greece is expected to present a new fiscal strategy that will include new austerity measures and privatizations, and the IMF staff may make a statement by the end of the week.

According to Zacks Investment Research, Office Depot has been persistently losing market share to industry stalwarts, recently posted lower-than-expected first-quarter 2011 results. The under performance can be traced back to sluggish sales across each business segment that suffered due to lower customer transaction counts and the divestiture of businesses in Japan and Israel.

Office Depot Balance Sheet Grade D

The company reported a 3.2% drop in the top-line and a break-even bottom-line, with both falling short of the Zacks Consensus Estimates. A sales decline of 3% at the contract channel of the company's North American Business Solutions division following failure to retain customers during the shift to the new purchasing consortium was also a first-quarter event.

Further, we remain cautious about the macroeconomic environment and sluggish job market with small businesses and consumers still remaining watchful on their spending.

On a reported basis, including one-time items, Office Depot delivered a loss of 5 cents per share, compared with 7 cents in the year-ago quarter.

Office Depot’s total revenue of $2,973.0 million fell short of the Zacks Consensus Estimate of $2,979.0 million and dropped 3.2% from the prior-year quarter, registering sales declines in each business segment.
Cost of goods sold and occupancy fell 2.9%, while general and administrative expenses inched down 1.4%. Meanwhile, store and warehouse operating and selling expenses inched up 0.6%.

Segment Performance

During the quarter, revenue for the North American Retail division slid 2.0% to $1,320.6 million. Same-store sales fell 1% versus the prior-year quarter. Office Depot hinted that customer transaction counts declined compared with the year-ago quarter but the average order value rose slightly during the reported quarter.

The division reported an operating profit of $58.0 million compared with $73.0 million in the prior-year quarter. Lower sales and increased marketing costs weighed upon the operating profit of the company.

Total store count at the North America Retail division stood at 1,141 at the end of the quarter. During the quarter, the company opened 1 store, closed 7 stores and relocated 2 stores.

Revenue for North American Business Solutions also dipped 3.0% to $806.2 million, due to a decline in customer transaction counts. The average order value remained flat compared with the year-ago quarter. Operating profit went down 19.8% to $16.2 million, reflecting lower sales and rising costs.

The International division’s revenue plummeted 5.0% to $846.1 million (in U.S. dollar terms). The division posted an operating profit of $27.3 million, down 34.4% from the prior-year quarter, reflecting a lower gross margin.

Other Financial Details

Office Depot, the operator of office supply stores under brand names such as Office Depot, Foray, Ativa, Break Escapes, Worklife and Christopher Lowell, generated negative free cash flows of $123.2 million during the quarter, compared with a positive free cash flow of $11.2 million in the prior-year period.

The company ended the quarter with cash and cash equivalents of $494.2 million, long-term debt of $657.0 million (reflecting debt-to-capitalization ratio of 47.5%), and shareholders’ equity of $725.8 million, excluding non-controlling interest of $0.5 million. Capital expenditures for the quarter came in at $28.6 million.

Zacks Investment Research View

Office Depot recently announced that it will be closing its nine existing stores in Canada on June 11. Furthermore, the company claimed that the move was part of its initiative to enhance its growth prospects by cutting down on investments in sections that no longer contribute significantly to its long-term growth.

Office Depot has repositioned itself to remain 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 are expected to contribute to margin improvement.

Office Depot completed the acquisition of Swedish office supply company, Svanstroms Gruppen, in February 2011. The acquisition will facilitate Office Depot to expand its European market presence, placing it among the leading office supply companies in Sweden.

However, we remain cautious about the sluggish recovery in the economy. As a result, consumers and small businesses remain watchful about their spending on big-ticket items such as business machines and other durable products. We observe that the demand for office products is closely tied to the health of the economy.

Given the pros and cons, we prefer to maintain a long-term ‘Neutral’ rating on the stock. Office Depot, which competes with Staples Inc. (NasdaqGS: SPLS - News) and OfficeMax Inc. (NYSE: OMX - News), holds a Zacks #3 Rank, which translates into a short-term ‘Hold’ recommendation.

Sell Short Office Depot – Ticker ODP

Sell Entry: 4.93 to 4.59

Stop-Loss: 5.33

Take Profit Areas: 3.73 to 3.66, 3.43 to 3.47, 2.25 to 2.21

Office Depot Company Profile

Office Depot, Inc., together with its subsidiaries, supplies office products and services. Its North American Retail division sells an assortment of merchandise, such as general office supplies, computer supplies, business machines and related supplies, and office furniture under various labels, including Office Depot, Viking Office Products, Foray, Ativa, Break Escapes, Niceday, and Worklife through its chain of office supply stores. It also provides printing, reproduction, mailing, shipping, and other services, as well as personal computer support and network installation service. As of December 25, 2010, this division operated 1,147 office supply stores in the United States and Canada. The company’s North American Business Solutions division sells nationally branded and private brand office supplies, technology products, furniture, and services to small- to medium-sized customers through a dedicated sales force, catalogs, and Internet. Its International division sells office products and services through direct mail catalogs, contract sales forces, Internet sites, and retail stores using a mix of company-owned operations, joint ventures, licensing and franchise agreements, alliances, and other arrangements. As of December 25, 2010, it sold its office products to customers in 53 countries in North America, Europe, Asia, and Latin America. This division operated, through wholly-owned or majority-owned entities, 97 retail stores in France, Hungary, South Korea, and Sweden; and participates under licensing and merchandise arrangements in South Korea, Thailand, India, Israel, Japan, and the Middle East. The company was founded in 1986 and is headquartered in Boca Raton, Florida.

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