Issue #0729/2 - Despite a further very bad set of financial results, Lexmark’s share price has stabilised.
Following the second quarter earnings announcements towards the end of July, Lexmark’s share price appears to have stabilised, following a steady slide of nearly 50% of its value over the previous eight months.
Prior to the second quarter announcement, Lexmark issued a revised outlook statement that contained little but bad news for the company, forecasting continued difficulties for the third quarter of the year.
Lexmark lists the current challenges as:
- Declining OEM Unit Sales
- Declining Inkjet Supplies Sales
- Aggressive Pricing Environment
- Product Cost Impacts
- Affordably Grow Hardware Shipments
Essentially, this means that the company is struggling to sell its hardware and inkjet supplies and cannot afford to do anything to reverse the slump because the company is not earning enough to allow it any financial flexibility.
Looking at the company’s history, my impression is that the first five years, following its creation by IBM in 1995, were incredibly exciting. Perhaps riding on the back of the IBM reputation, and because it was a new company presenting new and reasonably innovative hardware, growth was rapid and a position at the top of the market was quickly achieved.
Indeed, the share price experienced exponential growth up to the turn of the century, achieving a figure of about $135.
As time progressed however, and the break from IBM was finalised, Lexmark seemed to fall into a ‘we know best and can’t do anything wrong’ mentality, apparently ignoring any information or opinions that didn’t match up to its own expectations.
It goes without saying that this is an arrogant and dangerous stance to take and all the signs now are that Lexmark is paying dearly for that attitude. During 2000, the share price crashed in line with most of the industry as the dot com crisis hit. Recovery was slow over the following four years, achieving another high point of $100. But, from the middle of 2004, the underlying trend has been negative, to the current position where shares are worth only 38% of their 2004 value.
By comparison, the underlying trend for Xerox stock has been one of slow but steady growth since its low point in 2001 as confidence in the company has increased again and Hewlett-Packard’s share price has also shown firm and steady growth over the last five years.
Specific information presented in the second quarter statement indicated that Lexmark is remaining positive despite the 2% decline in overall revenue and a set of results that still offer little but bad news overall. Lexmark indicates that hardware unit growth ran into double digits and that revenue from supplies for laser printers experienced acceptable growth.
Apparently, there are ‘good growth opportunities’ but the question has to be asked, ‘is Lexmark capable of translating those opportunities into revenue and profit’? The company claims to be making progress on strategic initiatives – meaning the development of new hardware and achieving growth in key markets for branded equipment. It is also claimed that progress is being made in brand awareness.
Investments are planned for continued work on building the brand, together with generating extra demand for its hardware.
It is clear that the consumer market is performing very poorly for Lexmark – revenues declined 8% year-on-year while revenues in the business market grew by 3%. This shift means that the consumer market now accounts for 39% of Lexmark’s total revenue in comparison to 42% in the second quarter of 2006.
Compounding the problem, operating income in the consumer segment has fallen 80% in the last year whereas, for the business segment, operating income has remained stable (but 3% revenue growth means a slightly lower operating income percentage than last year).
Only four years ago, Lexmark was returning record revenues and growth rates for supplies were running at 11%. Now we are seeing that growth running at just 1%, with genuine growth in laser supplies revenue almost completely obliterated by the declining revenues from inkjet supplies.
Also, Lexmark is really struggling with its sales to other printer vendors and seems increasingly to be having to rely on its own branded hardware – which, although growing in terms of unit sales, results in increased pressure on the company.
As previously noted (Issue #0722"Consumers abandon Lexmark"): consumers are not buying Lexmark inkjet supplies; revenue from inkjet hardware sales has fallen, at least partly because of intense competition driving prices through the floor; and inkjet hardware has cost Lexmark more to produce than expected. Although hardware sales were said to have been higher than expected, this potential has to be translated into increased supplies sales – and this is the greatest challenge for Lexmark.
Continued increases in inkjet hardware sales, combined with declining inkjet supplies sales, reinforces the theory that customers are either:
- now viewing the purchase of a new printer as the cheapest means of continued printing (instead of buying replacement ink cartridges), or
- are so disenchanted by Lexmark hardware that they never replace the cartridges once exhausted but move to a different brand for their next printer.
For instance, pretty much at the bottom of Lexmark’s inkjet range is the Z1320. This machine can be bought for as little as €31.95 whereas the replacement colour cartridge (high yield) from the same store costs €28.99. Add to that the black cartridge at €23.99 (high yield) and we have a total cartridge cost of €52.98 – 66% HIGHER than the cost of the initial hardware!!
Printer vs Supplies - Lexmark Z1320
In fact, one of the Lexmark models has been spotted selling for £11.73 (about €17)!!
Lexmark is not alone in trying to combat this situation by offering low capacity cartridges as well as the high capacity cartridges. These are aimed at reducing the pocket shock factor for low print volume users by keeping the immediate expenditure relatively low. The trouble with this is that the cartridges need to be replaced more often, cost more per page and ramp up higher profit for the manufacturer!
However, these low-capacity cartridges cannot be bought at the same store as the printer and high-capacity cartridges used in this example! In fact, probably only one in three stores stock the low-capacity cartridges!
[Too many exclamation marks here – but the situation deserves them!!]
Even at the lowest price possible, the pair of low-capacity cartridges would cost a user €31.87 (a massive eight Euro-cents lower than the printer!!) and could cost as much as €40 – 25% higher than the printer (and perhaps more)!
Conclusion – why would customers not consider buying a new printer each time the cartridges run out?
Putting it all together, it is not in the least surprising that Lexmark stock has been in serious decline. From these Q2 results, one has to wonder why the decline appears to have slowed. It appears that Lexmark made no share repurchases during Q2, perhaps indicating that fewer shareholders are wishing to offload stock.
Certainly for Q3, despite the optimism referred to, the company is not forecasting anything good. Reductions in revenue are expected, as is reducing gross profit margin and operating income margin, with expenses expected to rise further.
One would suspect that the levelling off in the share price is a temporary situation only while the markets wait to see whether Lexmark can make good on its optimism and pull into recovery or not. Unless Lexmark can reverse the recent trends by the end of the year (with the inclusion of the Christmas buying season), the underlying decline in share price is very likely to resume as confidence in the company takes another hit.
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