The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.By Tim Begany NEW YORK ( StreetAuthority) -- Finally, the stock market and economy are doing noticeably better. Perhaps the most welcome sign is unemployment, which has gradually worked its way down to 8.5% from a recession high of 10.1% in October 2009. The S&P 500 has risen nearly 9% in the past three months and investors have been forecasting progressively less market volatility, as shown by a 35% decline in the
This poor competitiveness stems from Office Depot's inability to negotiate lower prices from suppliers the way bigger rivals can. And, Office Depot hasn't managed to develop a thriving e-commerce business, which is cheaper to operate than traditional retail outlets. Staples, by contrast, has evolved to become the second-largest Internet retailer behind Amazon.com ( AMZN). Considering the lack of major differences between competing products and the negligible cost for consumers to switch to another company's products, low-cost providers like Staples and even part-time players like Wal-Mart Stores ( WMT) are best-positioned to gain dominance. A higher-cost, lower-margin operator like Office Depot, on the other hand, will likely lose customers and could even end up having to close stores, particularly in North America, where the office products market is saturated. In fact, the company has already been closing stores in the U.S. and Canada for several years -- 121 in 2009 and 22 in 2010, for example -- and is now down to about 1,200 retail outlets worldwide. I think layoffs and more closings are possible during the next few years because management will need to cut costs further to achieve and maintain positive margins. Risks to Consider: Since Office Depot's downward spiral appears likely to continue, shorting the stock may seem like a no-brainer. Short sellers could get burned, though, if the stock reverses course for some reason, like small businesses recovering more rapidly than expected or swift action by management to improve profitability through deep cost cuts. Action to Take --> Office Depot is a terrible investment I see treading water, at best, because of the competitive disadvantages I mentioned. However, it's also easy to imagine the stock continuing its long decline, delivering another 8% to 10% a year in losses as it heads down to $1.80 or $1.70 a share from the current share price of around $2.80. And that estimate could be optimistic, since some analysts already value the stock at less than $1 per share. This seems reasonable to me when you consider investors have paid an average of 6.3 times earnings for Office Depot for the past 10 years. If you multiply that by 2012 estimated earnings of 5 cents a share, you get a share price of only 32 cents (6.3 x 5 cents = 32 cents).
Even if Office Depot manages to get back in the black in the long term (it has posted negative earnings for the past four years), it's probably not going to offer Staples or other big rivals major competition any time soon. Eight or 10 years down the road, we might even see headlines about Office Depot filing for bankruptcy. You may want to short the stock if you're adventuresome, keeping in mind the risks I've described above, but I don't see any other role for it in a portfolio. It's probably not even worth holding as a takeover candidate, since high degrees of product overlap with the competition mean Office Depot doesn't have much of anything new or complementary to offer potential buyers, except additional outlets. And even these wouldn't be that great an asset since many retailers are moving toward smaller stores and more online sales. Tim Begany does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article. More StreetAuthority stories:
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