Printer industry note: HP printing business suffering

Now that Lexmark is on my list of companies to research, I have been paying more attention to the printer market. I think it is essential for investors to figure out the business environment before investing in something. Reading some news stories on the competitors is one quick way to get up to speed.

HP is probably the market leader in the printer business. There are many different segments—home, business, commercial; inkjet, laser; etc—and HP doesn't always lead every single market segment but it is dominant in most segments. So, it's always good to see how the market leader is doing. Let me excerpt some points from a New York Times article covering HP's recent earnings results (as usual, bolds are by me):

In the last year, H.P.’s sales of printers and related supplies like ink have tumbled. The major cause for the decline remains the weak global economy. Businesses have spent less on printing products, and with unemployment high, fewer workers are around to hit the ink-burning Print button on their computer screens.

Analysts contend that the recession has created a culture of reluctant printer users. Companies have urged workers to keep a close eye on printing costs. So they are using less paper and choosing costly color ink as a last resort. Such policies push people toward digital documents they read on mobile devices as well as their computer screens.

...

H.P.’s printing group has long been one of the company’s star performers. It accounts for nearly a quarter of overall revenue. Printer ink remains one of the most expensive liquids on the planet — more valuable than expensive perfumes — providing H.P. with far higher profit margins than PCs and other types of computing hardware provide.

On Tuesday, H.P. showed how its printer business remained vulnerable to the recession when it reported third-quarter financial results. H.P.’s printing and imaging revenue fell 20 percent, to $5.7 billion, as sales of supplies tumbled 13 percent and sales of printers fell 23 percent.

These latest results add to several months of sharper than expected declines from H.P.’s printing group, and the company has been scrambling to raise prices and adjust its inventory levels to offset the slump.

“What has been the most striking issue for investors has been the fact that printer supplies have really fallen off,” said A. M. Sacconaghi, an analyst for the investment research firm Sanford C. Bernstein. “There was always this belief that people keep printing like they keep eating even during recessions.”

...

He [CEO of HP] said people examining H.P.’s printing results needed to take into account currency fluctuations that had hurt the company, as well as costs tied to inventory adjustments. For example, such costs, Mr. Hurd said, would account for most of the 13 percent slide in printer supplies revenue last quarter. The sales of ink by companies like Best Buy, Wal-Mart and Tesco were flat to slightly down, he said.

“People are printing just as much as they did last year,” Mr. Hurd said. Rather than curtailing their printing behavior, businesses and people have simply opted not to buy spare ink cartridges at the same rate as they did during better financial times, according to Mr. Hurd.

Still, H.P.’s printing supply revenue had grown at close to 10 percent in the three previous years, and has now fallen. And it is that sharp shift that has investors worried whether longer-term changes in behavior are at work, Mr. Sacconaghi said.

As the article points out, printer ink has very high margins*. So a collapse in usage severely hurts the business. This is especially true in the printer business, where printers are sold at a loss or almost-a-loss.

I don't know if management at HP, similar to Lexmark, have their head buried in the sand, or if they actually have a greater understanding than the analysts. The CEO seems bullish and suggests that the sales and profit declines are temporary (due to currency fluctuations and inventory adjustment) and nothing to worry about.

The key question, as the analyst mentions, is whether the changes we are observing are permanent changes or not. When sales fall 10% to 20%, is that a new level; or will it bounce back. Investors need to bet correctly on that (or conservatively assume the low level is the new norm.)



*SIDE NOTE:

When investing, you should always figure out who has the power to extract the highest profits in the supply chain. Classic example is Wal-mart. Wal-mart stock price was overvalued in the late 90's (all growth stocks were) so it's hard to tell by the stock price but, if we look at economic profits, Wal-mart has the easiest time extracting profits, while the suppliers generally live off low margins. Whether times are good or bad, Wal-mart makes money but the same isn't true for the suppliers. The worst off are probably the (mostly) Chinese manufacturers who live off extremely thin margins, and, according to some China bears, don't even cover their capital costs.

In the printer business, at least over the last two decades, ink has been very profitable. But the power to extract that profit lies with the printer companies and not the chemical companies who produce the ink. I'm pretty sure that the chemical companies that produce the ink don't make much money. I actually looked them up—there were two publicly traded ones I ran across—and they don't seem anything special. The chemical companies producing ink are largely producing a commodity and are simply a price-taker. If the printer company didn't like the producer then it will just walk away to another one. (note: I'm being simplistic here. Some printer companies manufacture their own ink and almost all use some custom-tailored ink so it isn't as simple as hiring some ink producer off the street.)