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Staples – Holding it Together, But for How Long?

cover-staples
By: Bob Cramer
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Staples, Inc. (SPLS), the world’s largest manufacturer of office supplies, opened its first store in North America in 1986, and has since expanded its operations to South America, Asia, Australia, and New Zealand. It generated over $24 billion in revenues in fiscal 2012 (FY12; ended February 2, 2013).

Read our detailed analysis of the company at: Staples – Not Much to Go By

Staples paid its first dividend in May 2004. Initially, dividend payments were only made on an annual basis, but the policy was changed in 2009 to allow quarterly dividend payments. The company has not only stuck religiously to the quarterly schedule since then, it has also increased dividends every year by an average 10.1%. Its stock yields over 3.5% of its current market price in dividends.

Allocation of Cash Flows      

Staples’s cash flows from operations (CFOs) have declined from around $2.1 billion in FY09, to nearly $1.2 billion in the twelve months to the third quarter (3Q) of FY13 (ends February 2, 2014).

The decline in CFOs has not really been a problem for the company, as its capex takes up a relatively small percentage of CFOs (29%) and the company has sufficient ex-capex cash flows to fund its dividend payouts.

Dividend payouts took up only 11% of Staples’s CFOs in FY09, but had increased to 26% of its CFOs in the twelve months to 3QFY13. The increase can be attributed to the fall in CFOs over the same period. (You can read up on why CFOs fell in our earlier piece.)

As the company pushes ahead with its aggressive cost-cutting measures, analysts estimate that CFOs for the full year FY13 will rise to $1.4 billion, and to $1.5 billion in FY14. If they improve as expected, the company will be in a better position to transfer earnings gains to investors.

Dividend Coverage and Payout Ratios

Staples’s dividend coverage ratio* – which gauges how many times the company can cover current dividends with ex-capex cash flows –  has declined from 4x in FY10 to 2.8x in the twelve months to 3QFY13. However, the ratio is expected to expand over the next two years as cash flows improve.

On the other hand, its dividend payout ratio – or the percentage of profits returned to investors as dividends – has increased from 29% to 35% over the same period. The full-year payout ratio for FY13 is estimated to be 39.5%, which is quite high. Therefore, though the company is expected to continue increasing dividend payouts in the future, it may not be able to do so at current rates, especially as earnings growth is not expected to be significant in FY14 and it cannot continue paying out higher shares of its profits each year.

*Dividend Coverage Ratio = Free Cash Flows/Dividends Paid

Liquidity Position

Debt-to-Equity Ratio

Staples’s total debt-to-equity (D/E) ratio improved from around 37.5% in FY09 to 32.6% in the twelve months to 3QFY13. With the exception of liabilities worth $500 million that mature in 2018, the company does not hold a significant amount of long-term debt that will mature in the next four years.

Staples’s improved D/E ratio and the fact that it has no major payments due in the next few years means that it can easily raise debt to fund dividend payouts, operations etc. if the need arises.

Net Debt to EBITDA

In addition to the improvement in its D/E ratio, Staples’s net debt-to-EBITDA ratio has also improved significantly from 0.6x in FY09 to 0.3x in the twelve months to 3QFY13. The fall in its net debt-to-EBITDA ratio signals a strengthening in the company’s fundamentals, and makes it easier for Staples to raise debt in the future.

Credit Outlook

Moody’s and Standard & Poor’s both maintain a stable outlook on Staples, and have given it investment grade ratings of baa2 and BBB. Fitch has also given it an investment grade rating of BBB, but with a negative outlook.

With those ratings, the company will likely not face a tightening in credit availability going forward, and seems to be in a pretty advantageous position right now due to its low D/E and net debt-to-EBITDA ratios.

The Bottom Line

Although the company’s performance has suffered due to sluggish sales in both domestic and international markets, Staples’s cost-cutting initiatives have been successful enough to prop up its margins up till now. The management seems well aware of the fact that large gains in revenues are a pipe dream in the short run, and is therefore looking for ways to squeeze the most out of its existing operations. Because of the aggressive rightsizing measures it has adopted, analysts expect marked improvements in the company’s cash flows from operations in the next year, which will help future dividend payments.

However, we do not believe the stock should be held by investors for more than two years, as the company’s product mix is rapidly being made redundant and it has been facing a corresponding fall in demand.

So while the company seems to be in a good position to keep increasing dividend payments in the upcoming fiscal year, an expected fall in revenues beyond that can increase volatility in cash returns which may limit the company’s ability to maintain dividend growth at current rates.

That puts us in a quandary. Staples does seem like a good dividend investment, at least for the next year or so, but we cannot recommend it to investors looking for something they can just buy and forget. If you are willing to take a position and are bullish on a possible reboot of the company, exercise caution and be on the lookout.

 

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