(OMX) OfficeMax Stays at Neutral

We have a long-term Neutral recommendation on OfficeMax Inc. (OMX) with a price target of $6.00. The company provides office supplies and paper, print and document services, technology products and solutions as well as office furniture to business firms, government organizations and other retail consumers.

How the Company Balances

As the recovery in the economy still remains sluggish, consumers and small businesses remain frugal about big-ticket spending like business machines and other durables. Therefore, we believe that the demand for office products is closely tied to the health of the economy.

Consequently, OfficeMax is repositioning itself to keep afloat in a difficult consumer environment. The company is containing costs, closing underperforming stores and focusing on innovative products and services, which should all contribute to margin improvements. Further, the company also anticipates regaining operating margins of more than 3.8% by 2015.

The company also focuses on optimal store sites in order to boost store productivity. Moreover, OfficeMax is committed to improve sales per square foot by increasing customer traffic and converting them into potential buyers by targeted advertising, ongoing sales training and customer-oriented initiatives. The company has initiated control center technology services to assist customers with PC maintenance or removal of viruses.

As part of its strategic retail partnership initiative, OfficeMax commenced a pilot program with RadioShack Corporation (RSH) in January 2012, under which the employees of the latter are selling mobile products and accessories and offering services in some of OfficeMax stores in San Francisco.

On the other hand, RadioShack is helping OfficeMax to enhance its consumer electronics offering. The initiative in a way is driving traffic as well as optimizing selling space utilization.

Balancing Act Brings Better Results

Amidst a tough economic environment, OfficeMax posted better-than-expected fourth-quarter 2011 results. The quarterly earnings of 17 cents a share beat both the Zacks Consensus Estimate and the prior-year quarter earnings by a penny, on the back of low single-digit growth in the top line and effective cost management.

Total sales climbed 3.9% to $1,835.8 million from the same quarter last year, and also came ahead of the Zacks Consensus Estimate of $1,812 million. The fourth quarter of 2011 included an extra week of operation in the U.S., excluding which, total sales edged down 0.8%.

The office supplies retailer now expects first quarter sales to remain even with the comparable period, including the impact of foreign currency translation. Sales for fiscal 2012 are projected to be flat to marginally higher than the prior year, including the positive impact of foreign currency translation and excluding the extra week in 2011.

Margins under Pressure, Competition a Threat

We observe that the gross profit margin during the fourth quarter of 2011 remained under pressure. Consolidated gross profit margin contracted 80 basis points to 24.5%. Contract segment gross profit margin shrunk 60 basis points to 22.2%, reflecting a rise in delivery expense on account of increased fuel costs and fall in customer margins. Retail segment gross profit margin shriveled 90 basis points to 26.9% attributable to higher promotional activity to drive traffic, inventory markdowns and rise in fuel expenses.

OfficeMax faces stiff competition from office supply retailers, such as Office Depot Inc. (ODP) and Staples Inc. (SPLS), and wholesale clubs, discount stores, mass merchandisers, computer and electronics superstores on attributes such as store format, pricing strategy and in-stock consistency. This may weigh upon the company’s results.

Let’s Conclude

Genuine efforts are implemented to combat the tough economy. Business budget remains tight, consumers remain cautious than ever before and companies are trying hard to navigate through the challenging maze.

Going by the pulse of the economy and given the pros and cons, we prefer to maintain our long-term Neutral recommendation on the stock. Moreover, OfficeMax holds a Zacks #3 Rank that translates into a short-term Hold rating.

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