Don't Expect the Max From OfficeMax

By Lawrence Rothman, CFA

I've tried to see the positives in OfficeMax 's (NYSE: OMX) earnings results. For example, bottom-line earnings were flat at $0.35 a share. Excluding certain items from last year, earnings improved by more than 20%. But I don't see this as firm evidence of the company's turnaround, and I won't be convinced until sales and margins improve.

Its contract segment, which sells directly to business customers, faces stiff competition, including office superstores Office Depot (NYSE: ODP) and Staples (Nasdaq: SPLS). It is a low-margin business, and getting lower all the time. OfficeMax's gross margin for the quarter fell 70 basis points, to 21.4%. New accounts and renewals are signing contracts at a lower rate, and given this trend, it wouldn't surprise me to see margins contract further. Also, it's not like the company is giving sweet terms just to get deals done. Sales grew a total of 4.4%. But even this weak figure doesn't tell the whole story. In the U.S., sales rose only 2.2%, but internationally, the 11.1% growth gets knocked down to 2.9% when foreign currency translation gains are excluded. Unfortunately, the segment accounts for about 56% of the company's sales.

OfficeMax's retail segment fared a little better, but not much. Its sales increased just 4.4%, and same-store sales rose 2.7% (adjusting for the company's decision to eliminate mail-in rebates and provide instant rebates). I realize sales performance was better than at Staples and Office Depot, but OfficeMax was also facing a very weak comps decline of 1% last year. The segment's gross margin expanded just 20 basis points, to 29.9%, citing more effective promotion strategies. Still, I don't believe margins can expand meaningfully unless top-line growth increases at a more substantial rate. This will be difficult, since it not only faces the aforementioned competitors, but also companies such as Costco (Nasdaq: COST) and BJ's Wholesale Club (NYSE: BJ).

Facing a very competitive marketplace, OfficeMax's distant third place in the industry may be threatened. The rumor mill is full of takeover speculation, and that might provide salvation. Going it alone may be an uphill battle.

© 2006 Universal Press Syndicate.