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Double-Hammered: Lexmark

July 25, 2012 | About:
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Barel Karsan

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It appears Lexmark has been hammered twice for the same result. Last week, the company pre-announced that it would miss earnings this quarter and next due to weakness in Europe, and the stock fell 25%. Yesterday, the company more-fully announced its earnings, and the stock was among the biggest losers again! Might this provide an opportunity for value investors?

Lexmark appears to have a recurring revenue stream, whereby it sells ink at a healthy price to customers that already own Lexmark printers. Despite this cash flow stability, Lexmark now trades at a P/E of around 5, even though it has a net cash position (albeit the money is stuck overseas, and therefore taxes would accrue if repatriated).

The company faced several headwinds this quarter that are expected to continue through the rest of the year. First, weakness in Europe, where Lexmark has a large part of its business, reduced demand. Compounding this problem is the fact that the weakness in macroeconomic conditions in Europe has hurt the Euro in dollar terms, hence reducing the dollar value of the revenue Lexmark does take in overseas.

Further hurting recent results was a price increase in April, which caused Lexmark's customers to build inventory pre-increase; they are now drawing those inventories down, thereby reducing Lexmark's sales. Finally, the company continues to let its consumer/retail business shrink, as it attempts to move up-market; Lexmark wants to sell its printers to high-usage customers, because the profits are in ink, not printers.

The bear case appears to be that printing is a dying business. Maybe that's true in the very long-term, but surely this industry isn't going away anytime soon. In the meantime, this company generates gobs of cash.

In my opinion, the biggest risk to investors is capital allocation. Management has a stated goal of returning half of the company's profits to shareholders (through a comnbination of buybacks and dividends)...but what about the other half? It is being invested in acquisitions for Lexmark's software business, which shows great revenue growth but is barely breaking even. Intangible asset writedowns may soon be necessary!

At the current price, however, it looks like management is intent on buying back shares, as per the company's conference call yesterday. For more discussion of this stock, see this related article and the comments at csinvesting.

Disclosure: Author has a long position in shares of LXK

About the author:

Barel Karsan
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 2.4/5 (5 votes)

Comments

superguru
Superguru - 2 years ago
"The bear case appears to be that printing is a dying business."

Printing may not be dying but definitely declining business. With Xerox, HPQ, CAJ, LXK and EPSON fighting for market share...How do I decide on winners?

This value investing in perpetually declining business/industries...Seems fraught with value traps.

this is not a comment on LXK as I have not looked into this business as yet.

stevenramsey
Stevenramsey - 2 years ago
What is the key in valuing a declining business? Someone asked this at Berkshire Annual Meeting this year and Charlie Munger said, "Well, it's worth less than a growing business." Ha!

But you've got something like Lexmark with a high earnings yield, which may not mean a whole lot, but it generates cash, you get a healthy dividend yield while you wait (+6%), and they're repurchasing a lot of shares. The high cash balance is mentioned, though only $80 mln is in USD.

In this situation, what you've got going for you with Lexmark is:

--high ROIC, high Earnings Yield

--share repurchases & dividends

--company with recurring revenue

--possibly huge catalyst if tax repatriation laws on overseas money gets changed

Comparing/Contrasting it to DirectTV:

--high ROIC, decent Earnings Yield

--massive share repurchases (no dividend) = tax free returns

--recurring revenue (stable base in US, growing base in Latin America)

--both subject technological change that could do real harm to the business model

--international exposure (though LXK seems more EU focused, DTV is LatAm)

--fairly simple/straight-forward businesses

So with opportunity cost, why would one choose LXK over DTV? This is not to sound smart allec, this is a question of curiosity and helping me (or anyone who reads this) think in a more 360 degree manner of business and valuation.

superguru
Superguru - 2 years ago
Good time to revisit Chanos presentation on value traps.
shaved_head_and_balls
Shaved_head_and_balls - 2 years ago
"This value investing in perpetually declining business/industries...Seems fraught with value traps."

For several years, speculative growth stocks have outperformed value stocks. In more recent days, many value stocks like LXK have been crushed beyond recognition. The huge disparity in overpricing of growth and underpricing of value usually means that the worm is going to turn in the not-distant future, tilting investor sentiment toward value stocks like Lexmark.

There is one great thing about the stagnant printing/ink business: There won't likely be many new entrants to the industry, which should allow the best players keep high margins and market share as the industry declines modestly over time.

I wouldn't be surprised to see Lenovo buy Lexmark. Lenovo bought IBM's PC division a few years ago. It would be fitting if they bought IBM's former printer division (Lexmark) at the current low price. This would strengthen Lenovo's portfolio of workhorse computing products.

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