Further Upside? Office Depot Shares Climb 121% in 82 Days and Remain Attractive

Office Depot (NYSE:ODP) is a stock the Investor Playbook team has revisited several times in our blog commentaries since November of last year.

When we first wrote about the stock on November 29th, shares were trading at $2.76. We since discussed the subsequent downward-wedge breakout that took shares up more than 33% to $3.68.

And we’ve continually said that ODP has been a very attractive investment opportunity.

In fact, some of our readers have expressed great satisfaction in riding shares up to $6.10 just a couple of weeks ago… and for those lucky enough to sell at those highs they earned a 121% return in just eighty-two days.

As you might imagine, much has transgressed with Office Depot in that time…

We’ve seen activist hedge fund Starboard Value accumulate ODP shares, Office Depot’s CEO leave to become CEO of another company, and most recently a marriage with its competitor, OfficeMax (NYSE:OMX).  The merger is an all-stock deal with OfficeMax shareholders receiving 2.69 Office Depot common shares for every one of their OMX common shares.  The merger is expected to close by the end of this year. 

Some research firms see the $13.50 worth of ODP shares that OMX holders get in the bargain as a poor deal – as they think OMX is worth more than that. Nevertheless, it was this merger announcement that helped rocket ODP shares into the $6 range…

What Now for ODP?

There will certainly be some synergies realized in this tie up of two office superstores, but whether they’re enough to outweigh a challenging overall sales environment remains to be seen. The effects of imminent sequestration can’t be a good thing for the top line of any big office supply retailer…

Maybe parts of the new combined company will be sold off. Starboard is good at making its opinions known, especially when it comes to thoughts on liquidating parts of Office Depot – including their push to see Office Depot de Mexico unloaded to Grupo Gigante. 

Fundamentals aside, we see continued short-term profit taking following the news of the new “office duo”.  In the chart below, we’ve highlighted some internal Elliot Wave counts to help us understand what we should expect going forward.

Here, we’ve essentially labeled five internal waves one through five. These are both common and definitive moves that help chartists anticipate a change in trend. With these five steps collectively marching higher, but going no higher than the peak of the fifth wave, investors have naturally shifted into the pullback stage of the move. The pullback (or ‘retracement’) is both healthy and necessary. Look for three legs which we’ll begin to label “A-B-C” very soon. To simplify this, think of the ups and downs as a repetitive dance with five steps forward and three steps back. Each step may be small or large but will ultimately fit into the rules of the theory itself.

Currently, the stock is retreating in the initial “A” stage. Expect shares to be held in check throughout the summer but going no lower than the 2012 bottom.

CHART: ODP’s Summer-Time Blues Will Likely Be a Good Buying Opportunity

Once this pullback “A-B-C” phase has ended, investors would be wise to continue their share buying at basement-level prices as the bigger picture Elliot Wave labeling is much more compelling in the long term.

We’re also focusing on the MACD indicator here which is a simple mathematical tool. It focuses on the moving average of price, placing emphasis on a broader price history versus a second plotted line which raises the level of importance for only the most recent price history.

If the MACD is falling quickly compared to price (as is the case as we write this), then we can arguably come to the conclusion that the pullback thus far is weaker than the bullish run that preceded it. A bit of a tongue twister to say for sure – but the point is clear – and it is that the stock has a high degree of underlying strength.

With that said, we remain confident that shares will eventually reach major resistance near $8.80 per share with the potential to continue its run well beyond this initial profit-taking zone. Look at any further declines throughout the summer as buying opportunities while Office Depot clears the merger tape and transitions into its new larger entity.

Investor Playbook

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