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    Are investors losing faith in Staples’ turnaround plan?

    With its stock and credit-defaults swaps under pressure, the road has been anything but easy for Framingham-based Staples.
    Reuters/File 2012
    With its stock and credit-defaults swaps under pressure, the road has been anything but easy for Framingham-based Staples.

    Staples Inc. is having its worst month in the credit-derivatives market in a year as investors’ doubts grow that a turnaround strategy at the world’s largest office-supply chain will overcome competition from discounters.

    Credit-default swaps tied to its debt widened 32 basis points this month to a mid-price of 187 basis points, according to the data provider CMA. Staples fell 2 cents a share short of analyst estimates for second-quarter earnings, and chief financial officer Christine Komola said Aug. 21 that full-year results would miss projections by at least 7 cents.

    While shrinking profits concern stockholders, bondholders are more focused on whether declining sales will diminish the cushion between revenue and interest payments and allow Framingham-based Staples to compete with lower-cost retailers, including Internet-only Inc. and member-supported Costco Wholesale Corp. The company’s stock is down 17 percent this month.


    ‘‘The market is rethinking if Staples and the rest of the office group has a long-term position in a commodity market against the Amazons and Costcos of the world — particularly in the important back-to-school time frame,’’ said Joel Levington, managing director of corporate credit for Brookfield Investment Management Inc. in New York.

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    Owen Davis, a spokesman for Staples, declined to comment on the credit-default swaps levels.

    The move in the swaps, the biggest since August 2012, chips away at the best year on record for the contracts, which fell to a two-year low of 148 basis points on Aug. 2, according to CMA, which compiles prices quoted by dealers in the privately negotiated market.

    Credit swaps, which typically fall as investor confidence improves, pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. The current price means investors pay $187,000 annually on a contract protecting $10 million of Staples’s debt.

    The levels imply Moody’s Investors Service should rate Staples debt Baa3, the lowest investment-grade level, while the retailer’s stock price indicates a Ba3, according to Moody’s Corp.’s capital markets research group.


    Moody’s grades Staples debt Baa2. It’s rated an equivalent BBB at Standard & Poor’s and at Fitch Ratings, which cut the outlook on its grade to ‘‘negative’’ Aug. 23.

    The company’s $500 million of 2.75 percent senior unsecured bonds due in January 2018 have fallen 0.13 cent this month to 100.76 cents on the dollar to yield 2.56 percent, 99.7 basis points more than similar-maturity Treasurys, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The bonds reached 103.07 cents on May 8.

    Staples, suffering from waning demand for products from ink and toner to computer accessories, cut its outlook for full-year earnings per share from continuing operations to $1.25, at most, according to Komola, trailing the $1.32 average of estimates compiled by Bloomberg and its own earlier projection of $1.35.

    Growth in its online and other segments ‘‘was more than offset by difficult sales trends in our international businesses and weak same-store sales in North America as demand for core office supplies fell short of our expectations,’’ chief executive Ron Sargent said on an Aug. 21 conference call held to discuss second-quarter earnings with analysts and investors.

    ‘‘We are not happy to be taking down guidance this morning,’’ he said. ‘‘We’re making good progress on our strategic reinvention, but it hasn’t been fast enough to offset the tough trends in some of our core categories.’’


    Same-store sales declined 3 percent, compared with last year, and the company closed 54 stores in North America, Sargent said. International sales fell 8 percent in the period ended Aug. 3, hurt by Europe and Australia.

    Revenue for the full 2014 year, which ends Jan. 31, is expected to fall 4.1 percent to $23.4 billion and remain at that level the following year, according to a Bloomberg survey of 18 analysts.

    Net income is projected to be $818.9 million this year, after a $210.7 million loss in the previous period, down from $984.7 million in fiscal 2012.

    ‘‘Staples has never really recovered from its expensive international expansion, and these operations continue to be a drag on sales and earnings,’’ Carol Levenson, the director of research in Chicago at Gimme Credit LLC, wrote in an Aug. 21 note. ‘‘Although the company carries little debt, its fixed obligations are considerable, and virtually all of its free cash flow is returned to shareholders, leaving little opportunity for credit profile improvement.’’

    The company repurchased $631.7 million of stock in 2013 and pays a 12 cents-per-share quarterly dividend that will cost it about $300 million this year, Bloomberg data show.

    Staples expanded its international unit to build market share as office-supply chains lose business to companies such as and Walmart Stores Inc. International sales peaked at $5.3 billion and fell to $4.4 billion last year, with a $21.2 million operating loss, Bloomberg data show.

    In Europe, the company closed 49 stores in the 12 months through the second quarter, according to an Aug. 21 statement.

    Staples’s two biggest domestic competitors, Office Depot Inc. and OfficeMax Inc., are combining to create a more formidable rival and offset declining industry sales. Office Depot said in February that it would buy OfficeMax for about $1.17 billion in stock.

    In changing its outlook on Staples’ debt, Fitch Ratings cited ‘‘the potential that current operating weakness could persist over the medium term.’’

    Moody’s is ‘‘comfortable with the current rating,’’ said Charles O’Shea, the credit analyst who covers Staples.

    ‘‘The company will do what it needs to do to stay within the triggers’’ the ratings firm tracks, such as retained cash flow and net debt, he said. Because the second quarter is often weak for Staples and its competitors, he said, it’s ‘‘never a make-or-break quarter for anybody in this sector. We’ll pay attention to the last half of the year.’’

    While shifting focus from brick-and-mortar to online business ‘‘takes time and it costs money,’’ Staples ‘‘has a cushion in the rating right now’’ to do it, he said.

    ‘‘We’re not CDS people; we try to look through the cycles,’’ waiting as long as two years without changing the rating as a high-grade company steadies after a transition, he said.

    ‘‘We try not to overreact to bumps in the road for well-run businesses, and we feel Staples is a very well-run company. There are a lot of innings left to play here.’’

    Debt investors may want to be paid more for their patience.

    ‘‘The spreads on the bonds, particularly longer than five years, don’t give me a whole lot of compensation’’ if the business model doesn’t improve, said Jason Brady, a fund manager who helps oversee about $86 billion at Thornburg Investment Management Inc. in Santa Fe. ‘‘The valuation just doesn’t encompass the buggy-whip risk for me.’’