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WALL STREET, CALIFORNIA | Stock Exchange / James Peltz
and Michael Hiltzik

Run Over to Staples, but Steer Clear of Silicon Graphics

September 14, 1999|JAMES PELTZ and MICHAEL HILTZIK

Stock Exchange lets readers listen in as Times staff writers James Peltz and Michael Hiltzik debate the merits of individual stocks.

Before We Start ...

Jim: Apparently the folks at Motorola read last week's column, Mike, in which we praised General Instrument.

Mike: That's right. As our colleague Sallie Hofmeister reported Monday, Motorola may be set to make a takeover offer for the company. Well, OK, maybe Motorola came up with the idea on its own, but clearly it sees the same potential in General Instrument that we do.

Staples (SPLS)

Jim: This is a busy time of year for this big chain of office-supply superstores, Mike, because it's a central location for back-to-school supplies. But actually Staples relies mostly on small-business customers.

Mike: And it would be even more of a central location today were it not for our crack Federal Trade Commission, which said "not so fast" two years ago when Staples tried to buy its chief rival, Office Depot.

Jim: The FTC nixed that deal on antitrust grounds.

Mike: Despite all the promises from these companies that the merger would not lead to higher prices, for some strange reason the FTC didn't believe them. But Staples' business just kept flourishing anyway.

Jim: Staples last year had $7 billion in sales. It's carved out the role of being one of the major "big box" retailers in its market, like Home Depot or Wal-Mart Stores in theirs.

Mike: Fair enough.

Jim: Staples' stock was a favorite for much of the '90s because the chain kept spitting out 20%- to 30%-plus sales and earnings growth year after year. This stock has split six times in the last six years. But suddenly this spring, everyone started getting skittish about Staples' outlook--so the stock has tumbled 37% since March 31, to around $20 a share now.

Mike: Care to account for that? Was it office-supply fatigue?

Jim: In a manner of speaking, yes. As interest rates started heading higher, people began fretting that Staples' stupendous sales growth might ease because small businesses might cut back their spending. With all the competition Staples faces from Office Depot and the rest, the worries deepened.

Mike: This is what happens when you post 24.7% sales growth instead of the 25.6% growth everyone expected. Horrors!

Jim: Your sarcasm is dead on, but that's the price a company pays when it's got a reputation for constantly exceeding everyone's forecasts. If there's just a whiff in the marketplace that you might come up a tad short, look out below.

Look at what happened last week, when Staples' stock lost 10% in a day because its CEO said, in effect, that things would be great but not necessarily absolutely fabulous.

Mike: And let's be honest, Jim, it's a fair question to ask whether there are enough shopping centers left where Staples can put new stores to keep expanding. Particularly when Staples talks about having a new strategy of opening even larger stores.

Even so, the perceived wisdom on Wall Street is that, of the big three chains--Staples, Office Depot and OfficeMax--Staples is the best at execution.

Jim: I certainly think it is.

Mike: So you'd buy this stock? Are you bottom-fishing?

Jim: Yep. The drop in Staples' price makes a great entry point to own this stock. Staples remains a proven, well-entrenched competitor, and I've noticed that its profit margins have been inching steadily higher in the last three to four years.

Mike: Hmmm, that suggests that Staples' improved margins are coming out of the hide of the companies that make the supplies Staples sells.

Jim: Maybe, maybe not. You know, you can still boost your earnings per dollar of sales--and not demand cheaper prices from your suppliers--if you control your inventories well and tighten other costs. And Staples does that.

Anyway, I also like Staples because it's planning to offer more services to small firms, and because it's focusing on selling lots of "consumables," which is the nickname for all that stuff you put in computers, fax machines and printers that gets used up--like printer cartridges. There's big money in all that. And I think all the fears about an easing of Staples' growth have been badly overblown.

Mike: There's a lot I like about this company, too, and I'd also buy the stock. But investors have to realize that its expansion opportunities are not infinite.

Jim: Nor is its high sales growth rate necessarily sustainable.

Mike: But it's fair to say that some of the tougher expansion is already behind Staples. After all, they're already in most of the markets where you find their two big rivals.

Jim: And where Staples has prospered, nonetheless.

Mike: Right. Staples' financial structure is also very healthy and its margins are growing, as you said. Also, its move toward more services will mean not only offering copying machines for customers, but computers and other electronic services.

Jim: Plus, Staples' Internet site is being tailored to help feed those services, and its supplies, to customers to complement its store traffic.

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