Lower sales, investments will prove a drag

Office Depot’s (ODP) margin performance is likely to remain under pressure as the company diverts resources toward transforming itself into a services-driven company.

Office Depot has cautioned that lower sales and ongoing investments are likely to prove a drag on its adjusted operating income for fiscal 2018. However, it says the synergies of $20 million expected from its acquisition of CompuCom should provide some cushioning.

Could Office Depot’s Margins Be under Pressure in 2018?

Office Depot expects pro forma sales to fall 5% to $10.6 billion in fiscal 2018. The main factor is the continued pressure on its retail division. The company also expects to invest $40 million toward becoming a services-focused company, which will dent its operating income in 2018. The company expects to incur $30 million in normalized compensation-related expenses and another $13 million due to the new pension and defined benefit plan expense.

For fiscal 2018, adjusted operating income is expected to be $350 million compared with $446 million in fiscal 2017. Despite lower operating income, management expects to report free cash flow of $325 million, which would be almost the same as fiscal 2017.

Office Depot is focusing on driving margin growth through prudent expense management and improving operational efficiency.

Past performance

In fiscal 2017, Office Depot reported a gross margin of 24%, down 60 bps (basis points) from fiscal 2016. It reported adjusted operating income of $446 million, a 2.2% fall due to lower sales and investments that continue to impact profitability. Its adjusted operating margin rose 20 bps to 4.4% in fiscal 2017.

The company has been cutting costs and winding down its international operations to improve profitability. It sold its European and Mainland China operations in 2017 and its Australia operations in February 2018. It’s now looking to divest its New Zealand operations.

Profitability numbers for peers

For fiscal 2019, Best Buy (BBY) has guided to an adjusted operating margin (on a 52-week basis) of 4.5%, the same as fiscal 2018. The company expects its operating margin to remain unchanged on a year-over-year basis in spite of growth investments since tax reforms are likely to prove a drag.

Genuine Parts (GPC) expects its operating margin to be driven by cost management and the acquisition of Alliance Automotive Group.

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