Eventually, even the best-run companies run out of levers to pull when it comes to producing more growth. Staples (Nasdaq:SPLS) is a fine retailer in many respects, and I don't believe that there are many (or perhaps "any") retailers that have built a quality online operation like Staples has.

SEE: 6 Sneaky Ways Online Purchases Are Hurting Your Budget

Unfortunately, Staples is stuck in an oversaturated North American market that just isn't likely to grow fast enough, while the ongoing economic problems in Europe have turned the international operations into a loss-maker. While these shares do indeed look meaningfully undervalued, they could stay undervalued for a quite a while yet, unless management can sell the Street either on new growth plans or a more aggressive cost-cutting strategy.

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First Quarter Results Basically Stable
All in all, about the best spin on Staples' first quarter results were that the company is not losing ground. Unfortunately, like a duck on a pond, there's a lot of activity going on just to keep its place.

Overall revenue dropped about 1%, as a sharp decline in International (down 8%) buried the flat performance in North American Retail and the modest growth (2%) in North American Direct. Same-store sales in North America were flat (versus down 0.5% a year ago), while European comps fell 6% (after falling 11% last year).

Although sales are not growing, management is making some progress on cost reductions. Gross margin dropped fewer than 20bp, and operating income fell less than 1%. Although International segment operating margin fell almost one point and North American Retail margins fell about a quarter-point, North American Direct margins improved by a third of a point and company-wide margins ticked up ever so slightly.

SEE: How To Choose The Best Stock Valuation Method

The North American Store Dilemma
The elephant in the room for Staples is that there's way too much elephant for the room; the North American market is over-saturated with office supply retail. It's not just about Staples, Office Max (NYSE:OMX) and Office Depot (NYSE:ODP), plenty of other retailers like Walmart (NYSE:WMT) and Costco (Nasdaq:COST) have targeted this market as well.

While Staples has fought back in part by expanding into ancillary/adjacent categories (breakroom and facility product sales were up 20% this quarter), how far can Staples really take this concept before it's just another indistinguishable face in the retailing crowd?

Likewise, store closure is no sure thing. Every one of the Big Three seems to understand that there are too many stores out there, but they all seem to be playing a game of chicken, hoping that somebody else makes a bigger move first. And why not? Why take the risk of losing sales by closing too many stores or the wrong stores? Perhaps Staples has an advantage with that strong online/delivery business, but for now, it seems that nobody wants to risk "over-closing."

SEE: The 4 R's Of Investing In Retail

The Bottom Line
I think Staples can push that online/delivery angle even further, but I don't know that there's enough juice there to really drive the stock on that basis. In the meantime, the shorts can just hammer away on this company/stock with the thesis that the era of big box retailing is over, and that these companies are all doomed to wither away and cannibalize each other on the way down.

Modeling just over 2% compound annual free cash flow growth suggests that Staples is meaningfully undervalued. Consider too that Staples' core addressable market (small/medium-sized businesses) is just now starting to see a real recovery.

Although the numbers suggest a fair price for Staples in the high teens, it's tough to recommend owning this stock today. Management is going to have to do something bold to lift the funk that hangs on these shares, and value investors may find that they lack the patience that it's going to take for this stock to work. With a better than 3% dividend yield, though, and a long run of positive free cash, this is at least a stock that can pay you for your time in the waiting room.

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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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