3 Reasons Staples Stock Could Fall

By Markets Fool.com

Shares of office supply company Staples have surged over the past six months, rising about 40% from the 52-week low. A strong earnings report last month, in which the company posted higher profits than expected, kept the momentum going, and I recently laid out a few reasons why Staples stock could continue to rise.

Continue Reading Below

SPLS Chart

SPLS data by YCharts.

Staples' business, though, still faces some serious threats that must be considered. Here are three reasons why this stock could reverse course.

Free shipping is becoming the norm

Staples has one of the most aggressive free shipping policies in all of retail, offering no-cost shipments through Staples.com with no minimum order size for members of its complimentary rewards program. Shipping times vary, but some items arrive as quickly as the next business day.

Continue Reading Below

Free shipping is quickly becoming table stakes for retailers, a process no doubt hastened by Amazon Prime, and many other retailers are becoming far more aggressive. Target, for example, is running a holiday promotion offering free shipping with no minimum order size through Dec. 20. Best Buy, while still requiring a minimum order size of $35, is advertising free two-day shipping on thousands of products, a move likely meant to combat both Target and Amazon Prime.

Staples is ahead of the curve on free shipping, partially because the company operates its own fleet of trucks, allowing it to bypass the couriers when it makes sense to do so. This free shipping policy certainly has a negative effect on margins, and as other retailers become more aggressive with free shipping offers, it might become more difficult for Staples to differentiate itself online. While Staples.com's sales growth has been accelerating, growing by 9% during the most recent quarter, widespread free shipping from competitors could create a headwind. If Staples' online sales growth slows as a result, the stock could suffer.

Planned store closings might not be enough

Staples is closing a large number of stores (170 planned for this year in North America, with more to be shuttered in 2015) in an effort to slim down its retail footprint and adjust to both the decreasing demand for office supplies and the continued shift to online retail.

Competitor Office Depot is doing the same, and the result will be a vast reduction in the number of office supply superstores in the United States. This should help Staples' profitability, but it's difficult to say how many stores need to close in order to stabilize sales. During the most recent quarter, Staples' comparable-store sales decreased by 4% in North America, and so far there's no sign the situation is improving.

It could take years of continued store closings and downsizings before comparable-store sales reverse course. While online sales are growing quickly, it's not enough to counteract weakness in retail. Staples has a strong commercial delivery business, but retail is the company's largest source of profit, and the prospect of continued revenue declines could weigh on the stock.

Office Depot's improving performance

Staples has long been the dominant force in the office supply industry, managing far higher profitability than Office Depot and Office Max. Now that those two companies have merged into the new Office Depot, this updated peer could becomea viable competitor to Staples.

Office Depot is being even more aggressive when it comes to store closings, and the company's profitability is slowly improving. While Office Depot is suffering from the same sort of sales declines as seen at Staples, operating margin in every segment improved substantially year over year in the most recent quarter.

While much is going right at Staples, with clear progress being made in areas such as online sales and commercial delivery, plenty could still go wrong. The stock has been volatile over the past year, and while its recent performance has been positive, serious risks remain for Staples' business.

The article 3 Reasons Staples Stock Could Fall originally appeared on Fool.com.

Timothy Green owns shares of Best Buy and Staples. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com and Staples. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.