Value Line is regarded as the best independent research available. More than just recommendations, Value Line provides the rationale behind its picks for greater understanding.
- Don D., California
Industry Analysis: Office Equipment and Supplies
The Office Equipment & Supplies Industry is subject to wide cyclical swings, the timing of which generally coincide with the fate of the U.S economy and, to a lesser extent, those of many European and Latin American countries. This industry is not capital intensive, and expenditures are often less than annual depreciation charges. There are two major sectors.
One includes companies that produce digital office equipment, such as copiers, printers, facsimile equipment, and postage meters. The largest customer category here is major financial institutions. Other important sources of revenue stem from small and mid-sized businesses and government agencies. The provision of management/outsourcing services supplements the top lines of these companies.
The second sector is made up of office supply distributors. Their sales are derived from North American retail chains, domestic contract stationery businesses, and international operations. Retail chain business is supplemented by Internet-sourced orders, which are factored into the calculation of same-store sales, a key barometer of operating efficiency.
Stocks in this group are relatively easy to analyze, given the straight forward nature of their businesses, the extended length of the product cycle versus most other technologically oriented industries, and the ease of determining market-share gains and losses. Investors must be mindful of the swings in the economy because of the industry's close link to the business cycle.
One prime growth strategy for product developers is the launch of enhanced models. New versions might feature color output, lower per-unit (page or envelope) cost, and increased functionality. Research and development expenditures as a percentage of sales and the amount of sales derived from products launched in the past, say, five years, are key analytical criteria. Another growth engine for product makers is the development and marketing of services that may have previously been performed by the customer's in-house staff. Such services involve document management, the maintenance of mail departments, and the servicing of printers/copiers. Geographic expansion is the third key growth vehicle that is utilized by all the larger players. Acquisitions supplement the above strategies, particularly the last.
Store openings, acquisitions, particularly in foreign countries, and competitive market share gains, within the contract stationer area, are the leading means of expansion for office supply distributors. These companies might also turn to alternate retail venues, such as copy and print shops, to create sales opportunities. Furthermore they will often enhance the allure of their Internet sites and "loyalty programs" (related to proprietary credit cards) to stimulate sales.
As is the case in the electronics industry, prices for office equipment and certain supplies, notably ink cartridges, tend to decline over time. The two main reasons for this are decreases in the price of electronic components (a result of the shift of production to lower-cost countries) and to increasing manufacturing efficiencies. More important, competition from large players in the Computer and Peripherals and Foreign Electronics industries limits the growth of office products manufacturers. Office supply distributors face market inroads by major retail chains outside the industry. All told, even in times of global expansion, the overall sales gains of the Office Equipment & Supplies Industry are usually modest.
In light of the foregoing growth assessment, the companies here have to continually struggle to maintain or improve margins. One prime method in supporting profitability for office product developers is cost cutting. This is done mainly by cutting administrative employees, outsourcing manufacturing and/or transferring this function to low-cost countries, and acquisition integration. Another means is the upgrading of products, leading to price increases. New service offerings are an additional relatively successful way of bolstering margins, since they typically command a high mark-up over cost.
Office supply distributors, in turn, offer high-margined technical diagnostic services, generally to repair malfunctioning equipment. Smaller-sized stores have also helped to shore up earnings, thanks to increased sales-per-square-foot and fewer in-store employees. There are wide operating-margin variances among companies in this industry, and the overall average is relatively low.
Large companies in this industry usually have Earnings Predictability ratings at the top end of our 100-point scale, while many of the others have much lower scores. There are also wide variances in the 3- to 5-year appreciation potential of these stocks. As might be expected, the peak upside potential occurs in the midst of, or at the tail end of, a global economic downturn.
As may be implied above, the biggest companies in this group have a relatively high level of depreciation charges. The result is that their "Cash Flow" per share is almost always much greater than share earnings. Accordingly, we suggest that investors examine the price chart on the Value Line page, which depicts the relationship between Cash Flow per share and a stock's price. A buying opportunity may be at hand when the Cash Flow line is above the current stock price; caution is likely warranted should the reverse hold true.