Wednesday, August 15, 2012

Hewlett Packard and the Other Printing Companies Look Challenged

One of the best ways to get a read on an industry is to look at what its distributors are saying.
With this in mind, I felt IT distributor Tech Data $TECD gave some interesting commentary. Investors in Hewlett-Packard $HPQ should be particularly interested as 10% of Tech Data’s revenues come from HP products.

In summary, Tech Data is currently seeing strength in mobility (cell phones and tablets), storage, virtualization, software and digital signage, whereas it is seeing weakness in printers, suppliers and consumables. I want to focus on printers and consumables, because I think there is something fundamental happening here that investors need to be aware of.

Back in the year 2000, I recall that technology analysts used to talk of the concept of the paperless office, almost as much as they used to salivate over the potential for 3G networks. Just as it has taken over a decade for smart phone technology to really utilize the potential of next generation networking, it is only now that the paperless office is truly appearing. With the advent of always-on connectivity and a plethora of new devices, it is becoming more attractive for executives and consumers to store documents in the cloud or on their devices. As such, the demand for printers seems to be in a secular down trend.


Hewlett-Packard Facing Challenges

A quick look at HP’s last quarter reveals the problem. The printing and imaging division managed a 10.4% revenue decline in the quarter and a 28.8% earnings before tax decline. Equally worrying, both hardware and supplies sales were down and there is little to suggest that this division isn’t in a consolidated decline. Unfortunately, based on the six month figures, this division still makes up about 26% of segmental profits, so if it continues to decline it will have a meaningful impact on profits going forward.

Tech Data had mentioned that storage was stronger so it is no surprise to see that HP reported a 1% gain there and the weakness in servers (down 6%) may well be due to customers waiting for HP and others to release Romley (Intel’s new server platform) based servers.

HP is a business in need of a turnaround. The stock is cheap on current fundamentals but Meg Whitman has a lot on her hands here. I wouldn’t expect too much from the Printing and Imaging division -20% of sales - and if the future is mobile, than the Personal Systems Division (Notebooks, Desktops, Workstations) -29% of sales - is also facing significant challenges. Indeed, these two groups are being combined in order to create synergy, which suggests that cost cutting is on the way, rather than wholesale divestitures. I suspect HP needs the latter.


Lexmark & Canon

Another famous name in the lexicon of printing machinery is Lexmark $LXK and it too seems to be in a consolidated decline. In the last quarter, overall revenue declined 4% with gross profit down 2%. "Core" revenue (laser and business inkjet hardware and supplies) only managed a 1% increase whilst "Legacy" (consumer inkjet hardware and supplies) declined 34%.

In fact, Lexmark intends to exit the latter business, a move probably more comfortable for them than for HP. HP has a lot of other consumer products, and printers help keep up brand recognition.  Analyst forecasts for Lexmark have revenues and earnings declining over the next two years and it’s hard to see how it can generate a turnaround.

The other great name in printing is Canon $CAJ and whilst it is seeing some single digit growth from emerging markets in Asia, net sales to the Americas declined 3% in the last quarter. Similarly, sales to Europe went down 11.9%.  I see nothing in any of these numbers to suggest that this isn’t a structurally challenged industry.


Iron Mountain Stock

All of which calls into question the long term sustainability of Iron Mountain $IRM and its core document storage division. Admittedly, there are some industries such as insurance and law that will always require hard documentation and Iron Mountain is expanding in electronic storage. However, the shift toward electronic file management rather than paper is a strong one and clearly evidenced by the results of the printer companies above.  The company is pursuing growth in Brazil and its challenge will be to shift revenues whilst it fights difficult trends in developed markets.


Printing Money?

In conclusion, none of the printer manufacturers have reported good results and HP’s integration strategy is open to question. I think this is a structural trend and investors need to be careful before diving in. If history is a guide, these sorts of industries will experience further decline followed by consolidation. Lexmark has already started the process by planning an exit from the consumer inkjet business and I would expect more of these types of developments to come.