Office supply giant Staples (Nasdaq:SPLS) is perhaps the strongest operator in a competitive and crowded industry. Staples competes with some very successful rivals online, and though it goes up against weaker rivals in the physical store realm, the space is probably too crowded. Exposure to Europe also remains a concern and likely will for some time. Overall, the stock’s valuation is low enough to leave substantial upside going forward.


Recent Developments
Staples recently reported results for its fiscal first quarter. Reported sales fell 1% to $6.1 billion but were about flat when stripping out the negative effects of currency fluctuations. The only segment to report positive growth was North American Delivery, which distributes office supplies via mail order and online. Amazon (Nasdaq:AMZN) is a key rival in this space but Staples holds its own and also managed to report operating income growth in this unit. Sales rose 2% to $2.6 billion while the operating income margin increased three basis points to 7.87% of sales.

SEE:Understanding The Income Statement

North American retail experienced a slight sales decline to $2.3 billion, as well as a modest fall in profitability as operating profits fell 43 basis points to 7.18% of sales. Staples reduced headcount in the division, which accounted for the more severe profit drop. Key rivals in this space include OfficeMax (NYSE:OMX) and Office Depot (NYSE:ODP), as well as retail giant Wal-Mart (NYSE:WMT).

International continues to be a laggard, reporting an 8% sales drop to $1.2 billion. Staples cited weakness in Europe and Australia, with comps dropping 6% in Europe. The unit also reported an operating loss for the quarter.

Total company operating income ended up falling 8.7% to $318.1 million. Lower tax expenses tempered the net income decline to 5.6% as the bottom line fell to $187.1 million. Share buybacks meant earnings fell only a penny to 27 cents per diluted share.

SEE: A Breakdown Of Stock Buybacks

Outlook and Valuation
Staples expects full year sales growth in the low single digits and earnings growth in the high single digits from $1.37 per diluted share reported in fiscal 2011. Analysts currently project sales growth of 1.2%, total sales of $25.3 billion, and earnings of $1.49 per share. This puts the forward P/E at eight.

SEE: 5 Must-Have Metrics For Value Investors

The Bottom Line
Efforts to diversify into international markets are not paying off and have put Staples in the midst of sovereign debt worries in Europe. The region is not a huge contributor to Staples overall, and a complete breakdown of the European Union remains remote, but will likely continue to keep the company from surprising on the upside for quite some time. Improvements in the home market also remain tepid. The stock has significant upside potential and could end up back at $20 per share should conditions improve, but there is likely no hurry for investors to jump in with a full position.

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At the time of writing, Ryan C. Fuhrmann did not own shares in any of the companies mentioned in this article.

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