Office Supply Chains on the Brink

The news coming out of Goldman Sachs' retailing conference can be called cautiously optimistic. While the conference is just getting under way this morning, trends are already emerging in the company presentations. The two biggest stories so far are the outlooks provided by Office Depot (NYS: ODP) and rival OfficeMax (NYS: OMX) . So far things look good, but there's uncertainty about what's in store for the long term.

Filed under "E" for excellent
Both companies have reconfirmed their 2012 full-year forecasts, which translates into a 4% to 8% earnings growth target for Office Depot, and a flat year for OfficeMax. That's good news for Office Depot, which has been struggling this year, and is currently undertaking a major store downsizing program. The hope is that, with some leases coming up for renewal, the company can cut its operating costs back, and focus on the products that consumers really want.

OfficeMax has had a better year, after recovering from a weak first quarter. The company has emphasized the broader economic context as a negative impact on performance, while Office Depot has repeatedly said that it would take the weak economy as an opportunity to focus on its core products. In a statement issued before the retail conference, OfficeMax also addressed its complex balance sheet, which has worried some analysts, and said that it will continue to try to simplify its accounting.

All of that is good news for the sector, which has come under pressure with both the weak economy and the move away from large chain stores. Office Depot's attempt to address these issues is a step in the right direction, but may not be enough to win back consumers. The office stores are increasingly under pressure from companies like (NAS: AMZN) , which can offer the same products, often cheaper and delivered for free.

The trouble ahead
The headwinds of competition and consumer woes will continue to haunt office supply chains throughout the rest of the year. As Reuters has pointed out, many people look to office supply chains as a reflection of the broader economic landscape. As demand for pens, paper, and electronics rises, it should indicate that small and medium-size businesses are succeeding. But the reverse is true as well. If the outlook for the economy is weak, then investors can assume weak demand will flow through to office supply chains.

That's certainly been the case at Staples (NAS: SPLS) , which announced a drop in earnings per share of 28% last quarter. The company attributed the fall to weakness in its core business categories, which was driven by weakness in the U.S. and European economies. That danger is being compounded by the influx of online competition, which has already done so much damage to other box-store chains. Amazon's Prime offering has free two-day shipping, which is certainly going to attract some small businesses that don't have the manpower or need for a dedicated office supplier relationship. If the big chains can't buck these trends, then it could be a very difficult next few quarters, and that's what investors should be worried about.

The bottom line
It's easy to look at these chains and see value. None of the three chains is trading above a forward P/E of 10, which reflects the hesitance that investors have shown. I don't think that's cheap; I think that's fairly priced. The niche that office supply chains once filled is disappearing, and while it's nice to try out 46 pens before you buy that next box of Bics, it's not going to keep them up and running. I think OfficeMax has the right idea, although it's about three years late: Trim down to stay afloat.

I'd steer clear of all three major office suppliers for now, and instead spend time researching Amazon, which is the clear winner in this area. The Fool has a new special report, which details what we think about Amazon and tracks the company as new events unfold. We'll update you with our newest findings, and keep you apprised of whether we think it's a buy or not. You can sign up for your copy today.

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