Market watchers have heaped much praise recently on Ed Lampert, who engineered the
merger last year and became Wall Street's highest-paid hedge fund manager. But what about the executives that were actually running the companies where he struck gold?
Lampert's presence as an activist stakeholder has been the common thread at retailers delivering dizzying investment returns in recent years, like Kmart,
and now Sears Holdings. Meanwhile, the management teams in place at these companies have often gone ignored amid all the hagiography.
One of those executives, Lampert's handpicked chief executive at AutoZone, Steve Odland, is embarking on his own cost-cutting mission at
. Investors are curious to see if Odland can work his magic there without taking cues from the Guru of Greenwich.
Office Depot plays second fiddle to
, the best-in-breed retail chain in the office-supply space. Its stock price was in a funk until Odland came aboard in March, when it subsequently jumped 19% in five days, crossing the $20 mark for the first time since 2002.
Before that, the three-year reign of its former CEO, Bruce Nelson, was viewed with disappointment. Nelson resigned in October, after Office Depot lowered its guidance for its third quarter and the full year, and reported a second-quarter earnings miss. It suffered 16 straight quarters of declines in sales at stores open at least a year from 2000 through 2003.
"Bringing in Steve Odland was a major coup for Office Depot that pretty much solidified their spot as the No. 2 player in office-supply retailing," says Morningstar analyst Anthony Chukumba.
Previously, there was speculation that the company's competitive position could be under fire from a third player,
. However, the reputation of OfficeMax's new chief executive, Sam Duncan, isn't that of Odland, and the company is already under investigation by the
Securities and Exchange Commission
for accounting problems that came to light last year.
Meanwhile, few observers see a chance for Office Depot to overtake Staples, but there is opportunity for Odland to cut costs.
"Clearly, there's room here for operating margin improvement at Office Depot, and given his track record, I'd say Odland is just the guy to do that," Chukumba says.
At AutoZone, Odland took the focus off sales growth and whittled down the company's cost structure, a strategy that was famously employed by Lampert at Kmart as well. On Odland's watch, AutoZone's operating margins doubled, while its stock price more than tripled.
That could be ported to Office Depot. In the first quarter, Staples logged a 7.8% operating margin, compared to 4.2% at Office Depot.
Office Depot spokesman Brian Levine said the company is reviewing opportunities for improvement in its cost structure, although no targets have emerged. Credit Suisse First Boston analyst Gary Balter said in a recent research note that the company has the potential to reach operating margins of 5.8% in 2007.
If the company reaches that goal with minimal sales growth, according to Balter, it might earn $2 a share in 2007. With a conservative valuation of 15 times earnings, that would push shares of Office Depot up to $30, giving the stock an upside potential of roughly 30% at current levels. These days, the stock trades at 16 times its earnings estimates through 2006.
"While we believe margin expansion will be the key to
Office Depot shares initially, the longer-term question is whether Odland can build a leading growth retailer, as his prior success at AutoZone involved higher margins but declining market share over the past couple years," Balter says. "That remains a key question, but not one that will prevent shares from rising with better margins, and cash flow that can fund share repurchases and drive EPS."
Balter expects operating margins to decline for the retailer this year, only to rebound to 4.5% in 2006 as Odland's strategy takes hold. The company could take a hit in the near term from restructuring charges in its European operations, where the retailing environment is ailing from a stalling economy and the rise of the dollar against the euro.
"In Europe particularly, we believe we have a solid opportunity to take costs out of our existing cost structure," Levine says.
Office Depot is the leading office-supply retailer in Europe, where it derives around a quarter of its total revenue.
Meanwhile, the company still feels it has potential to grow its top line in North America, where it operates 1,000 stores. In 2005, it plans to open 100 more stores, and in 2006, it plans to add 100 more. However, some of those openings are expected in the Northeast, where Staples has its most potent foothold, and analysts question whether Office Depot will be able to make much of a dent.
Staples, on the other hand, is poised to open 20 new stores in the Chicago area.
"That could hurt Office Depot," Chukumba says. "At the end of the day, the office-supply market is just not growing that quickly, so I think we're getting pretty darn close to saturation and that could hurt margins at all three of these guys."
Early next month, Office Depot is expected to report second-quarter earnings of 24 cents a share, according to consensus estimates reported by Thomson First Call. That would mark a slight improvement over a year earlier, when it reported earnings of 23 cents a share. For 2005, analysts expect the retailer to earn $1.25, which would mark a 14% increase over its 2004 results.
By comparison, Staples is expected to earn $1.10 a share, an increase of 18% over last year. Its superiority is mainly evidenced by revenue gains across all of its business units and comparable-store sales gains that reached 4% in North America in the first quarter. Office Depot's comps were up only 1%, and its total revenue gain missed estimates.
Still, Lampert's companies have routinely turned seemingly lackluster sales gains into extraordinary returns on investments. If the market is really nearing saturation, an investor's best bet for finding value could lie in Office Depot's bloated cost structure and Odland's ability to cleave it back.