Wednesday, July 25, 2012

Double-Hammered: Lexmark

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

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