Update: For the Dividend Growth Index – sold position in Staples Inc. (SPLS) on missed earnings and low margins, and purchased a position in Johnson & Johnson (JNJ).
The Office Sector Slump
While stock markets are on a tear since their declines in May this year, the office supplies retail sector has not been doing so well. Sales, profits and revenues have been declining , leaving the office supply retail sector in a bind. Take the smaller player in the industry Office Depot (ODP), with a 450 million market cap, which last June closed all its Canadian retail locations. Office Depot has a razor thin profit margin of only 1.01%. When I looked at the office supply sector back in May 2011, Office Depot was worth over 1.1 billion dollars.
Then there’s OfficeMax Inc. (OMX) with a market cap of 476 million dollars and a 1.5% dividend yield. It now has a profit margin of only 0.59% and a massive debt-to-equity ratio of 272%. In other words, the company is worth 476 million, but carries over 1.71 billion in total debt on the books, and is virtually unprofitable.
That leaves Staples Inc. (SPLS) which is still the dominant player in the office supplies sector, with a current market cap of 7.6 billion dollars (it was over $12 billion last year). It’s doing far better than its main competitors ODP and OMX, with a profit margin of 3.72%, and a solid debt-to-equity ratio of only 30%. It is also a solid dividend payer with a 3.9% yield, and raised its dividend in March 2012. Staples Inc. definitely is a well managed company, doing the best it can in a slumping retail industry. In May 2011 I initially wrote about Staples Inc. Value in Office Supplies, and why I felt it had an economic moat in this sector. I also felt that it would make a great value play, even with its low profit margin. Back then SPLS was trading at $16.95 per share after a missed earnings report.
Is Staples a Value Play or Value Trap?
In August 2011, I purchased shares of SPLS for my own portfolio at $14 per share. I then chose Staples Inc. as one of my Stock Picks for the Dividend Growth Index, with its great fundamentals as a pure value play. The one consideration for Staples however, was its thin profit margin, which has become its Achilles heel. Although I still think Staples is a well run company, and has solid fundamentals compared to many other companies, it’s caught in an industry trend. That trend is an overall decline in the retail sales sector, which has especially hit hard in the retail office supply sector. That trend was recently confirmed, as Staples missed earnings once again on Wednesday Aug. 15th, sending the share price down to a low of $10.99 during the trading day, and closing at $11.49 per share. In my own portfolio, a stop-loss for Staples was triggered at $12.
In light of the 5% decline in sales for Staples during the last quarter, and declining margins, I consulted with the other Dividend Growth Index (DGI) bloggers. I asked them if they thought it would be prudent to sell SPLS in the Dividend Growth Index at this time, or hang on for the potential value play. I decided I would go with the group decision. All agreed it was prudent to sell SPLS now and purchase another position.
Another blogger I’ve been following, Dividends for the Long Run, recently wrote a great post Opportunity In Staples. He’s crunched some interesting numbers, and also sees a potential value play for Staples Inc. at this price point. However he is cautious with this value play as a whole. Whether Staples Inc. at this price point is a deep value play or value trap remains to be seen. ;)
Johnson & Johnson (JNJ)
In my own portfolio I purchased shares of Coca-Cola (KO) with the proceeds from Staples Inc. However in the Dividend Growth Index, the Dividend Guy has already purchased a position in KO. Obviously we can’t duplicate positions in the index. So I chose the dividend powerhouse Johnson & Johnson (JNJ) as my replacement position.
Johnson & Johnson, together with its subsidiaries, engages in the research and development, manufacture, and sale of various products in the health care field worldwide. This is a 186.7 billion dollar company, with strong brand and global recognition.
Johnson & Johnson has a profit margin of 13.47%, and a debt to equity ratio of only 29.07%. The annual dividend yield is 3.60%. JNJ has a current annual dividend of $2.44 per share, with an annual EPS of $3.14, resulting in a current dividend payout ratio of 77% (other statements show an EPS of $5.04). The fundamentals for JNJ are rock-solid, though the share price is currently trading near its 52 week highs. This is a set-it-and-forget-it dividend champion that will make a great addition to the dividend Growth Index (DGI).
Readers, what’s your take? Would you have sold or held Staples Inc.? Do you hold shares of Johnson & Johnson (JNJ) in your portfolio?