According to the company,
Lexmark International, Inc., (Lexmark) is engaged in developing, manufacturing and supplying printing and, imaging, document workflow, and content management solutions for the office. The Company operates in the office imaging and enterprise content management (ECM) markets. Lexmark's products include laser printers, inkjet printers, multi-function devices, dot matrix printers and associated supplies, solutions and services, and ECM software solutions and services.
As the world moves towards a more digital existence, many believe that printing is a dying industry. To a degree, these critics are correct. Consumer printing revenues and margins have been on the decline for a while with HP (HPQ) seeing the most recent effects of this. While the declining consumer printing segment may hurt everyone in the Computer Peripherals segment, Lexmark should be less affected by this due to its recent shift in its business model. Lexmark has been significantly de-emphasizing its consumer printing segment. According to its most recent 10-Q:
Inkjet based products within the distributed printing market historically have served customers in the consumer market, but there is an increasing trend toward inkjet products being designed for small office home office (“SOHO”) and businesses.
The consumer segment has always been a low-margin segment with stiff competition coming from international competitors leading to extreme price competition (just think how cheap a printer is now; sometimes it's cheaper to buy a new printer than ink for that printer). By focusing on larger, stickier clients in the business segment, Lexmark has seen much better margins than many of its competitors:
As you can see, Lexmark is handily beating competitors in their own space.
Another driver for Lexmark is its recent foray into enterprise content management. According to AIIM,
Enterprise Content Management is the strategies, methods and tools used to capture, manage, store, preserve, and deliver content and documents related to organizational processes. ECM tools and strategies allow the management of an organization's unstructured information, wherever that information exists.
According to analysts in TechNavio, ECM is expected to grow to $9.6 billion in 2014. While Lexmark is a new entrant into the market, it has been extremely aggressive in acquiring companies that will increase its presence in the space. Lexmark should see increased revenue and profit from these divisions even though growth is slower than expected, as John Gamble, CFO, noted in the most recent earnings call [see transcript]:
For Perceptive Software, our focus is growth, and revenue grew again, up about 15%. EPS performance, however, at $0.95, was at the low end of what we expected, generally driven by items less operational in nature.
While Lexmark may no longer be the growth company of its past, I still see extreme value for a company that has maintained extremely high margins and increased market share in the growing ECM space.
Lexmark shines even more when compared to its peers on valuation metrics:
As we can see, Lexmark is undervalued when compared to both Cannon (CAJ) and Xerox (XRX). Lexmark's valuation may be affected by the fact that it is focused solely on the printing segment while CAJ and XRX both have differing business segments. Lexmark is also the least leveraged of the peer group and has the strongest balance sheet with $1.22 billion in cash and marketable securities alone (almost 50% of market cap).
The real positives of Lexmark are its cash flow numbers. For the nine-month period ending September 30, 2011, Lexmark has generated free cash flow of $251.6 million from operations. Lexmark's trailing twelve month cash flow margin is 12.07%. This is a huge amount of cash flow for a company that has almost no debt. Lexmark's quick ratio is 1.07 and its current ratio is 2.01! This is an extremely safe company that has demonstrated the ability to generate huge amounts of cash flow while growing organically without the need for external financing. In fact, the company has over half of its market cap in cash alone. Lexmark is a cash-flow machine with margins that should be maintained.
Now that you've heard the explanation of what Lexmark does and why it appears to be undervalued, what is the catalyst for multiple expansion? There are a few things that could cause Lexmark's stock to pop up.
- Lexmark's multiples move into line with its own peer group. As shown above, Lexmark appears to be the most undervalued of its peer group by far. The market seems to be taking into account Lexmark's declining revenues while failing to see the reasoning for its revenue declines. Lexmark has lost over 50% of its revenues from the consumer segment but still saw an overall increase in y/o/y revenues of 1% in the most recent quarter. The growth in other business segments should more than make up for the lost revenue from consumers. When the market realizes this, the market should move its multiples up closer to its peer group.
- Lexmark's own actions should stabilize or even increase the share price of Lexmark. Lexmark has been aggressively buying back shares of its own stock over the second half of 2011. The company expects to complete $250 million in buybacks in the second half (roughly 10% of current market cap). Lexmark also initiated a $1.00 per share dividend which is roughly a 3.00% yield at today's prices but with a payout ratio of only 23%. Lexmark clearly has room to grow its dividend especially with the cash flow it currently generates. As we have seen this year, U.S. high-quality dividend paying stocks have performed well this year and should continue to do well as the world deals with increased volatility and uncertainty from Europe and China. Institutional money, specifically income funds, may not have invested in Lexmark earlier but should be able to now with its very high yield.
- Lexmark is the perfect LBO candidate. I'm not the first to note that Lexmark should be watched by PE firms. Lexmark has generated extremely large amounts of cash flow over the years, has very little debt on its balance sheet, and is in an extremely stable industry (consider it a technology "razors and blades" company). Lexmark has lowered the odds of an LBO with its share buyback plan and its dividend initiation. The company still generates enough cash flow to cover both but PE firms may also be scared off by the poison pill provision Lexmark has. Even with this, Lexmark is still a great LBO candidate and could see some action in 2012.
I think Lexmark is undervalued on a variety of metrics. If P/E multiples expand, and Lexmark continues its slow but steady EPS growth, Lexmark could see a price of almost $55. My plan is to remain in Lexmark, collect my above 3% dividend yield and wait to see some multiple expansion or an LBO firm buy the company out. Overall, the market is not taking into account Lexmark's growth in its new business focuses (business printing, ECM) and paying too much attention to declining revenues due to headwinds (abandoning the consumer printing segment).
Disclosure: I am long LXK.