A Very Unusual Pre-Earnings Upgrade for Lexmark

Lexmark International Inc. (NYSE: LXK) saw its shares rise handily on Thursday, mostly on news of an analyst upgrade. Credit Suisse’s Kulbinder Garcha raised his rating to Neutral from Underperform.

Yes, you read that right, it was not a Buy or Outperform rating. And here we have seen a 7% gain to $30.74 shortly before the close. The rating itself is far from optimistic, and it was interesting to see that Garcha merely maintained his official price target of $31.00 in the call.

Because Lexmark is in the business of making and selling printers and ink cartridges, investors don’t want to pay up for this stock. Garcha’s $31 price target implies a price-to-earnings (P/E) ratio of only nine times the firm’s fiscal year 2016 estimate of $3.49 earnings per share (EPS).

It seems odd to see an analyst upgrade of this sort ahead of earnings next week. This stock is wildly unpopular. Again, who wants to own a printer company? Garcha said that management is guiding reported revenues of -4% to -6% versus a year earlier, or 0% to -2% in constant currency terms, and guiding an EPS range of $1.05 to $1.15. Garcha said:

Given the stock has underperformed the S&P500 by over 70% since March 2011 and we have a price target of $31, we upgrade the stock to a Neutral from Underperform, and await the outcome of strategic review… The company is considering a split, among other options, in its strategic review. We note the relative size of the printing business versus the software segment, with Printing contributing approximately 80% of revenues and over three times as much to operating income as the Software segment.

One issue that should seemingly be obvious is that the printing business is in decline. Hardware was shown to be down about 9% in the first nine months and laser supplies were also down by about 9%. Garcha further noted:

Declining hardware sales pose a challenge to stabilization in supplies revenue, which have now declined on an annual basis since Fiscal Year 2011. We note that Supplies have seen year over year declines consecutively for the last 7 quarters. We project a hardware decline of -11.5% in 2015 and -4.0% in 2016, and overall supplies decline of -13.2% in 2015 and -8.9% in 2016 (with laser supplies down -9.5% in 2015 and -6.5% in 2016.

Lexmark’s $30.74 price on Thursday compares to a consensus analyst target of $30.80, and the stock has a 52-week trading range of $24.11 to $47.69.

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