Office supply giant Staples (Nasdaq:SPLS) reported third-quarter results on Tuesday that saw earnings beat expectations. The company also offered a cheerier outlook on its near-term prospects, which sent the share price higher. This has lowered Staples' current investment appeal, but its competitive position warrants keeping any eye on the stock. IN PICTURES: How To Make Your First $1 Million

Recent Results
Sales fell 6%, to $6.5 billion, as the top line fell in the double digits in the North American delivery and international operating units, which accounted for 38.5% and 21.5% of total sales, respectively. Management cited lower customer spending on deliveries and a 9% fall in European same-store sales on smaller average orders and lower foot traffic as the primary culprits to the sales struggles. The North American retail segment did eke out a 1% sales increase to account for 40% of total sales, even though same-store sales were flat and Staples closed as many stores as it opened during the quarter.

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Profitability improved markedly as costs to integrate and restructure last year's acquisition of Corporate Express took a big bite out of last year's third quarter. On a recurring basis, operating income was flat in the domestic delivery business and fell slightly in the domestic retail and international units, indicating that consistent profit growth has yet to return to the company. Management said it was seeing improving trends in its catalog orders and "solid profitability in our European office products portfolio." On a reported basis, earnings improved 68% to 37 cents per diluted share.

Competitive Landscape
Staples competes with Office Depot (NYSE:ODP) and OfficeMax (NYSE:OMX) in the domestic retail climate. Both rivals remain mired in the red, with Office Depot announcing a 17% drop in sales and $413 million loss during its most recent quarter. OfficeMax reported a 12.5% sales decline during its third quarter and eked out positive net income of 7 cents per share. As such, Staples is performing better than its archrivals in a difficult operating environment. Also, a recent Barron's article detailed that Staples is the second largest online retailer, behind only Amazon (Nasdaq:AMZN), which speaks to its ability to successfully compete in a growing and highly profitable segment of the retail industry.

The Bottom Line
Management also boasted of "record free cash flow" as operating cash flow grew 36.2% to $1.6 billion and capex was cut by 21.6%. This capital was used to support a current annual dividend yield of 1.4%, repurchase a small amount of shares, retire debt from the Corporate Express purchase, and still left enough to send cash on the balance sheet to over $1 billion, though long-term debt ended the quarter at $2.5 billion.


Based on current analyst earnings expectations, shares of Staples are trading at a lofty P/E multiple of over 21. Top-line trends continue to recover, with analysts projecting a full year increase in the mid single digits. Cash flow trends are also improving and will get a further boost as Staples continues to pay down debt taken on from acquiring Corporate Express. In total, the company valuation is slightly ahead of where it should be, based on where fundamentals stand currently, but this could easily change as consumer and business spending on office products perks up or the stock trends back toward $20 per share. (Read Analyzing Retail Stocks to learn about the most important metrics to look at when analyzing retail stocks.)

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