Friday, May 29, 2009

Office Depot (NYSE:ODP): Upgraded to Overweight at JP Morgan

JP Morgan is out with a major call on Office Depot (NYSE:ODP) upgrading the shares to Overweight from Neutral while raising their price tgt to a whopping $8 (prev. $5).

Firm notes they are upgrading ODP to Overweight for the following reasons: 1) a modest normalization of the economic environment over the next year combined with ODP’s high macro correlation and apparent liquidity over that timeframe; 2) the potential for upward cash flow/earnings revisions against negative Street sentiment; 3) significant multiple expansion to reach peak valuation on trough earnings; and 4) the dissipation of the liquidity governor on the stock.

All in, they see a 3-1 risk-reward scenario. Firm's Dec 2009 price target of $8 is based on 8x EV/EBITDA using 2010 forecasts, 0.4x price to sales, and discounted normalized earnings of $1 in 2012.

Not for the faint of heart. This is an out-of-consensus call: ODP had 1 buy, 12 holds, and 3 sells prior to JP Morgan's upgrade. They also want to emphasize that this is not for the faint of heart. ODP has demonstrated inconsistency since 2006, and management has lost some credibility. Also, 2Q could be the worst quarter of 2009 for ODP given seasonally low revenues.

Looking for the first leg. JP Morgan believes ODP has sufficient liquidity to carry it through the next year unless the macro environment takes another significant leg lower (i.e., sales continue to decline at a high teens rate over the next four quarters with no benefit from the -7% and -15% compares in 3Q08 and 4Q08, respectively). The call is based on their expectation that yoy U.S. GDP and payroll growth become modestly positive over the upcoming 12 months. Recall, ODP’s top-line growth rate is 70%+ correlated to these factors. This is about the first leg of the stock’s recovery: peak multiple on trough earnings. Looking back to 2001, ODP began moving higher three quarters prior to the bottom in yoy GDP and payroll growth.

Shoots of green. All three office superstores commented that domestic retail comp trends have stabilized excluding the Easter shift. Moreover, SPLS recently indicated that its smallest customers in NA Delivery are also showing early signs of stabilization. The consumer/small business customer led the U.S. into the recession and they are likely to be the first to begin the procession out.

Notablecalls: First off all, the $8 tgt is set for December 2009. So, JP Morgan is pretty much calling for 100% upside in the next 6-7 months.

Also, as they note this is a out-of-consensus call. When you have something like this coming out of a tier-1 firm you better pay attention. Usually a table turner.

All in all, I think this one can trade over $5 level today.

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