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Office Depot in the Dumps

By Brian Lund (TMF Tardior)
May 26, 2000

Today was a bad day at the office for shareholders in Office Depot (NYSE: ODP). The world's largest office supply store (in terms of sales) warned that its second-quarter earnings per share would fall $0.04 to $0.06 below the $0.24 that analysts were expecting. The company cited three problems:

• Low comparable-store sales, a.k.a. comps, in May, but it gave no specific numbers.
  
• The strong dollar in Europe will translate into weaker sales than anticipated, though sales were better than expectations, measured in local currency.
  
• Anticipated savings from improvements in distribution weren't materializing as quickly as expected, which will hurt margins.

Well, pluck my eyes out and call me a wall socket -- you'd have to have had a private audience with the Delphic Oracle to have seen that coming! Low comps? Strong dollar? Insufficient efficiency? Office Depot?!?

The comps shortfall hurts, of course, but it's hardly unexpected. Comps at the U.S. stores have been middling for some time now, and I mean some long time:

      1995 1996 1997 1998 1999 2000Q1
Comps  17%  5.0  1.0  3.3  2.4  5.0

Office Depot has increased sales in the U.S. primarily through expansion. Sales per average square foot actually decreased slightly in fiscal 1999 and in the first quarter of 2000. The company has had a secret weapon, however: international stores.

International sales have kept Office Depot in the game for the last four years. The company operates 26 stores in France and has recently opened six outlets in Japan, in addition to catalog and Internet sales. Overseas revenue grew 26% in fiscal 1999 on 17% comps. The segment has come to represent 13% of total sales at Office Depot. Without it, the company wouldn't have reached double-digit annual sales growth in the last three years.

What's more, operating margins in the international division are far better than those in the U.S. division or the business services segment, regularly coming in a full 450 basis points higher. That's a substantial difference in a company whose overall operating margins rang in at 5% last year.

In the first quarter of this year, when the dollar had already begun to strengthen in Europe, international sales growth got dragged down from 27% in local currency to 18% in greenbacks. That would have made the company fall short of estimates then, were it not for the unusually strong comps at the U.S. stores. Who'd have guessed that comps would hit 5%, after so many dim years?

Well, they aren't that good anymore, and the dollar's still strong, so sales are going to fall on their face and margins will be lower. It really wasn't a matter of if this would happen, but when. Investors with an eye on revenue sources and comps saw it coming without the help of divine intervention.

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