The True Winner in the OfficeMax Inc (OMX)/Office Depot Inc (ODP) Merger

The value trap:

Lastly, separating the classic value trap from legitimate opportunity is one of the most difficult tasks for value investors. Currently, Staples is priced as if its going out of business, which clearly is not the case. The business is actually growing and quite profitable. While industry growth is stagnant, it’s not going away either. Business formation will grow commensurate to GDP growth and these businesses will need supplies…it’s that simple. The rationalization of the excess store base will provide an additional tailwind for Staples.

A few final points to make the case for SPLS

The business throws off huge cash flow – over $1 billion annually and growing.

The company has generated (and continues to generate) above average return on capital over the past decade. This displays a strong competitive advantage in a difficult environment.

The company has a new and growing revenue stream in the break room supply business.

Shareholder friendly management with increasing dividend payouts and share buybacks. Dividends per share have almost tripled over the past seven years.

The company continues to restructure the dismal Eurpean operation.

Recently, debt pay down and refinancing of approximately $2 billion in debt will add about $.15 per share after-tax to the bottom line.

At the current price of $13 per, it’s trading at just over .3X revenue. I expect the company to be able to maintain operating margins (if not improve due to restructuring) at the 6% level. Giving this level of profitability and consistent cash flow, the stock could easily trade at a more historic .6X to .7X revenue – giving it a price target of $22 to $25 per share. That’s significant upside without any expectation for growth.

There is no doubt that Staples faces a challenging environment going foward, but at this valuation level, the risk reward is very attractive. Limited downside with potential high upside – this is a good value opportunity.

The article The True Winner in the Office Max/Office Depot Merger originally appeared on Fool.com and is written by William DeRosa.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.