Did You See “Office Space”? The Printer Scene? Read On
Ever since Johannes Gutenberg developed movable type around 1439, making machines for putting ink on paper has been a growth industry. But that trend is likely to end soon.
Companies that make office printers and copiers have had a tough time recently. Xerox Corp. (XRX), Lexmark Inc. (LXK), Canon AG (CAJ) and Hewlett-Packard Co. (HPQ) have all been reporting weak financial results. They blame the global economic slowdown for reducing the amount of pages that get printed each month.
But investors have reason to worry that the cyclical problems may be reinforcing a secular decline. If businesses and individuals are printing less because they don’t need printed pages, the companies that supply office printers could face even bigger long-term problems. Now Microsoft Corp. has joined Apple and Google in making electronic tablets that can replace printed paper. That increases the opportunity for government, education and corporate customers to abandon binders full of printouts and shift their workers to screens.
Making office and consumer printers and copiers used to be a wonderful business. Once a device was installed, the manufacturer reaped the rewards for years as customers kept buying pricy ink and toner. At the high end, there were lucrative service contracts as well. But when volume flattens out, it’s a brutal market with many well-established competitors competing fiercely for every point of market share.
Printer and copier companies have produced increasingly capable devices. Sales of color-laser printers and multi-function devices that copy, print, scan and fax, have provided growth spurts, even as traditional black-and-white printing and copying shrinks. But fundamentally the industry depends on the number of pages printed to drive revenue, and if pages don’t increase, the business is in trouble.
All the stocks of printer makers have been hammered over the past two years.
Their chances of rebounding with a cyclical pick up in printing seem dubious. The record industry and the newspaper industry both initially blamed sharp downturns on recessions. But investors who awaited a rebound watched their stocks continue to plummet.
To be sure, futurists who forecast a paperless office as far back as the 1980’s have been burned repeatedly. Market researcher IDC says that last year, worldwide page volume from digital printers fell just 1% to 3.09 trillion pages from 3.12 trillion. It predicts small gains in page volume through 2015, even in the U.S. market where tablet alternatives are having the most impact.
A number of factors point to lower volume, however. Companies are encouraging employees to be “green” by avoiding unnecessary printing. Growing use of cloud services like Google docs lets people share documents electronically without ever printing them out. The printer companies themselves have set up businesses managing print services for their customers and promising to slash print budgets.
Signs of decline are everywhere. U.S. postal service mail volume, fell to 168 billion pieces in 2011 from the record 213 billion in 2006.
And these companies have seen significant two-year revenue declines:
The companies’ PE ratios reflect investors’ gloomy view of their prospects, with only Canon above 10.
Xerox and Hewlett-Packard both have book-value per share that is less than the current share price. And Lexmark and Canon stock prices barely top their book value.
They boast dividend yield ranging from 2.6% for Xerox to a hefty 5.6% for Lexmark. Several of the companies have share repurchase programs that can also bolster results.
But value stocks are only valuable if their businesses are stable. Managing declining businesses to maximize value is incredibly difficult. When they go into decline, the value usually disappears. Eastman Kodak Co. -- another company that was good at putting ink on paper -- was a blue chip a decade ago, but it is now struggling to emerge from bankruptcy court protection.
The printer companies are all struggling to manage their deteriorating businesses to maximize returns while controlling costs. Most have hopes of reaping gains from diversified businesses. But they remain stubbornly tied to print.
Lexmark, the smallest of the companies is the least diversified. It is in the process of shutting down its inkjet printer operations in order to concentrate on the faster growing laser printer and multi-function device markets. It predicts a fourth quarter revenue decline about comparable to the 11% decline in the third quarter.
Lexmark’s market cap is rapidly falling toward its book value.
Xerox made a big diversification move in 2010, acquiring Affiliated Computer Services, a business process outsourcing firm, for $6.4 billion in cash and stock. Services now account for over half of Xerox revenue, although one-third of them are related to managed print services. Unfortunately, the service margins are much lower than the margins for printers, copiers and supplies, so gains from the acquisition have been meager. Xerox continues to cut costs and it just announced another restructuring program.
Xerox’s market cap is actually below its book value.
Canon may be most familiar as a camera company, but 50% of its third quarter revenue came from office products such as laser printers and multi-function devices. Its imaging systems, including digital cameras and inkjet printers for photographers and home offices were 39% of revenue with the remainder coming from lithography equipment for semiconductor makers. Third quarter revenue fell 13% to $10.26 billion driven by the strong yen and weak printer sales, especially in Europe.
Canon has managed to grow revenue since the last recession, but investors are concerned, as shown by its declining market cap. Canon says it expects low growth in the fourth quarter, leading to a 0.7% revenue decline for the full year and a 5.8% profit drop.
The biggest company by sales among the top-tier printer makers is Hewlett-Packard, which has long counted on its market-share-leading printers to provide an outsize portion of profits while accounting for about 25% of revenue. The printer business woes are an afterthought for most investors. They are dwarfed by H-P’s problems with its services business, the declines in desktop PC sales and weak returns on its huge investment in software-maker Autonomy. Those issues largely explain the collapse in H-P’s market cap.
But declining printer revenue compounds the company’s problems, because they used to be H-P’s profits bulwark. Results reported in the third quarter ended July 31, showed that the lucrative printer supplies business fell 7.3% to $12.14 billion.
Hewlett recently introduced a number of new multi-function devices, and CEO Meg Whitman said that previous management had failed to keep H-P competitive in the fastest growing portions of the market. She has boosted R&D spending across the company in an effort to preserve H-P’s position.
Every company in the printer business counts on engineering and product development to deliver products that will provide a growth avenue. But if businesses and individuals print less, great products won’t make much difference.
Charles LeCompte, longtime imaging industry analyst with Photizo Group, says that the hard-copy industry “is in upheaval,” with printing revenue far below the pre-recession peak. He is skeptical that diversification will help them. “Historically, companies in a dying or “disrupted” market seldom successfully leap into new markets,” he notes.
Bill Bulkeley is a contributing editor at YCharts, which includes the just-released YCharts Pro Platinum for professional investors.
Filed under: Company Analysis