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(Office supply sector outlook upgraded with analyst downgrade.)



) -- The viability of office supply retailers is in question after



slashed its full-year outlook.

The sector, which is generally considered a gauge of the health of small businesses, has seen weaker demand from its corporate customers. This is raising concerns that the economic recovery is not making its way down to this space.

Oppenheimer analyst Brian Nagel cut his ratings and price targets on Staples and



, expecting sales in the sector to remain weak for some time.

"We believe that these results further undermined already cautious sentiment toward the office products group, as they show that now even sector leader Staples is not immune to ongoing macro and competitive pressures," Nagel wrote in a research note.

Nagel lowered both Staples and OfficeMax to perform from outperform, but maintained his perform rating on

Office Depot

(ODP) - Get Free Report

. He also slashed Staples price target to $19 from $26 and OfficeMax to $9.50 from $14.

Staples reported earnings on Wednesday of 28 cents a share on revenue of $6.17 billion, missing analysts' estimates of EPS of 32 cents on revenue of $6.20 billion.

Management now foresees 2011 earnings in the range of $1.35 to $1.45 a share, down from a prior outlook of $1.50 to $1.60 a share. The company said it expects little improvement in the economy this year and is also less optimistic about sales, calling for growth in the low-single-digit percentage range.

The weakness from Staples was both due to international sales and margins and an aggressive promotional environment in the U.S., Janney Capital Markets analyst David Strasser noted. "So essentially nothing really worked in the first quarter."

Staples is now providing further evidence that the issues that plagued both Office Depot and OfficeMax may not be company-specific.

In April, both

Office Depot and OfficeMax reported lackluster first-quarter results


Office Max posted a 54% drop in its profit and said it foresees flat sales in the second quarter, while Office Depot swung to a surprise loss during the quarter.

--Written by Jeanine Poggi in New York.

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Jeanine Poggi


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