Wednesday, December 21, 2011

OfficeMax: Worth 75% Less Than It Was 1 Year Ago?

One year ago, OfficeMax (OMX) reported quarterly operating income of $41 million, resulting in a market cap of around $1.5 billion. This year's third quarter was remarkably similar, with the office supplies distributor once again bringing in operating earnings of around $41 million. But today, the market cap sits at just $380 million, despite an improved balance sheet from last year!

At first glance, it would appear as if this company's debt burden justifies the low price. But the fully-consolidated debt line item doesn't apply. As discussed in a previous post, most of the debt is non-recourse, as it is held in a bankruptcy-remote subsidiary. Considering only the debt the company is actually responsible for, OfficeMax actually has a net cash position. At $200 million, it's a net cash position that represents more than 50% of this profitable company's current market cap!

Make no mistake, however, this is a low margin business. But Mr. Market's asking price fully takes this into account: the price to sales ratio is 0.05! (Note that Staples trades at a P/S of 0.35.)

New management came in about a year ago with the goal of increasing margins incrementally over the next three to four years. The new CEO is stressing more pilot programs and more measurements of the success of those programs (rather than large, risky investments that may not pay off). He appears to be expressing some confidence in the most recent results (or the low stock price), as he has been buying shares in the open market.

Last time OfficeMax traded at this price, it was April of 2009. Once again, it appears likely that macroeconomic issues have pushed this high-beta stock down to a level that doesn't make a lot of sense on a micro level.

Disclosure: Author has a long position in shares of OMX


Anonymous said...

It is a mistake to anchor on the price from the past. That is not the value investor way. Furthermore, this is a business that is being destroyed without mercy by the Internet. The same "value investors" that have been crushed by investments in BBY will get hurt here. Moats are not there with this company...

mik said...

By ignoring the non-recourse debt, you are assuming that the company would liquidate. But who wants that? Neither the creditors of the non-recourse debt, nor the management.

As long as the company is a going concern and it keeps paying off the debt, it's a burden alright and the cash will keep flowing away to the creditors.

Anonymous said...

Are you assigning most of the value of OMX to its asset value? Looking at its earnings or cash generating abilitiy and its ROIC, it appears to be worth very little. How would you assign a fair value or intrinsic value to this company?

Saj Karsan said...

Hi mik,

No I'm not assuming that. Half the debt will be written off when the Lehman bankruptcy is concluded (in the next few months) and for the other half of the debt, there is an asset called "timber notes receivable" that will be applied towards it. If that receivable falls through, the debt will be extinguished anyway, as it is non-recourse.

Hi Anon2,

No, the thesis is based on an estimate of its future cash flow plus its current cash position.

mik said...

Thanks, Saj. This makes things clear.

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