OMX Officemax Incorporated

We recently upgraded our long-term recommendation on Staples Inc. (SPLS), the global leader in the supply of office products, to Neutral with a price target of $16.00, following better-than-expected second-quarter 2011 results. Earlier, we had an Underperform rating on the stock.

The quarterly earnings of 22 cents a share topped the Zacks Consensus Estimate of 19 cents and jumped 10% from 20 cents delivered in the prior-year quarter. However, on a reported basis, including one-time items, Staples delivered earnings of 25 cents a share, up 38.9% from the prior-year quarter.

Staples now expects third-quarter earnings in the range of 46 cents to 48 cents and fiscal 2011 earnings between $1.39 and $1.45 per share. On a reported basis, including one-time items, the company expects to deliver earnings in the range of $1.42 to $1.48 per share in fiscal 2011. Earlier, the company had projected fiscal 2011 earnings between $1.35 and $1.45 per share.

Staples reported total sales of $5,819.6 million that rose 5.2% from the prior-year quarter, and came ahead of the Zacks Consensus Estimate of $5,653 million. Management now forecasts sales to increase in the low single-digits in the third quarter and fiscal 2011, respectively.

Being a leading retailer of office products and services, Staples is better positioned than its competitors to sustain its growth based on margin expansion, effective merchandising, and growth prospects across its retail, delivery and international divisions.

Staples is making prudent investments in the highly fragmented North American retail market to expand its business technology, and copy and print services that generate higher profit margins, while enhancing its core supplies categories like ink and toner. The company is also focusing on controlling expenses.

The company has been also actively managing its cash flows. The company is returning much of its free cash to shareholders via dividend and share repurchases. During the first half of 2011, Staples repurchased 19.2 million shares for $345.6 million. Management forecasts capital expenditures of approximately $400 million and expects to generate free cash flow of over $1 billion in fiscal 2011.

Staples faces stiff competition from office supply retailers, such as OfficeMax Inc. (OMX) and Office Depot Inc. (ODP) and warehouse clubs, discount stores, mass merchandisers, computer and electronics superstores on attributes such as store format, pricing strategy and in-stock consistency. This may weigh upon the company’s results.

Moreover, we remain cautious about the macroeconomic environment and sluggish job market. The decline in business and consumer spending, and weak credit markets have slowed the demand for 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.

Staples holds a Zacks #3 Rank, which translates into a short-term Hold rating.

 
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