Lexmark Intl (NYSE:LXK) -- What its Beaten Earnings Estimate Means for Investors

Lexmark International (NYSE:LXK), the Lexington, Kentucky-based printer manufacturer, announced that its second quarter earnings per share edged out consensus analyst estimates. Investors immediately rejoiced… but for good reason?

Agora Financial editor of the Strategic Short Report, Dan Amoss, takes a closer look in his latest missive to readers:

“Lexmark (NYSE:LXK) reported $1.07 in second quarter EPS this morning. This slightly beat the consensus estimate of 93 cents. Considering the market’s reaction, you’d think they had announced the invention of a perpetual motion machine.

“The stock was up about 10% on the news. In just the first 45 minutes after the market opened 3.2 million shares traded. This is more than the entire increase in the short interest in LXK since May. This is effectively a ‘mini’ short squeeze of shorter-term traders who’d expected a worse quarter. The odds of a further short squeeze are low, considering that there’s plenty of trading volume, and many shareholders will sell into this price spike.

“This type of ‘earnings beat’ is not new. Lexmark blew away analyst estimates by wider margins in each of the last three quarters. The intraday high for the year occurred on April 27, the day Lexmark reported first quarter results. We’re likely to keep seeing a similar retracement of today’s gains:

“This company is very hard to model on a quarter-to-quarter basis. So many variables drive short-term results. As I noted in the May 21 issue, even management doesn’t have a good real-time read on end market demand. Small short-term surprises can propel EPS up — or down — depending on the direction of the surprise.

“Lexmark is still digging back out of the massive hole it fell into in 2009. This is driving short-term earnings. But we know the long-term economics of this business will be terrible. Demand for printing will keep shrinking.

“Let’s keep this overhyped quarter in perspective. Lexmark’s revenue by geography is just approaching the levels it achieved before the soft depression started. The recent year-over-year growth rates are lapping very easy ‘comps.’ Look back the deeply negative 2Q09 numbers. Europe in particular — Lexmark’s most profitable market — is decelerating. It was up only 8% this quarter, reversing just a fraction of the 25% collapse in 2Q09:

“These high annual growth rates will soon head back to zero. Here is a similar chart showing year-over-year growth by product line. A key driver of the earnings ‘beat’ is the fact that high-margin supplies (toner cartridge) revenue is still growing. This is mostly due to temporary supply chain restocking:

“As soon as the third quarter, I expect the second derivative (or the rate of change) of supplies revenue to turn down. This should drive gross margins lower, and signal a return to the ugly long-term dynamics of selling printers and toner cartridges.

“Beyond this short-covering rally, the market is likely to look past this temporary revenue bump driven by inventory channel restocking, and price LXK stock at a much lower multiple.”

Since the announcement, Lexmark management has provided aggressive third quarter earnings guidance. Notably, several of leading economic indicators that flow through to Lexmark’s revenue have since collapsed, and Amoss indicates the conference call’s Q&A also showed most analysts remain skeptical of Lexmark’s revenue and earnings sustainability.

You can learn more about opportunities to profit from Lexmark’s current position by signing up for Dan Amoss‘ newsletter. The Strategic Short Report is available through the Agora Financial reports page, which can be found here.

Best,

Rocky Vega,
The Daily Reckoning

[Nothing in this post should be considered personalized investment advice. Agora Financial employees do not receive any type of compensation from companies covered. Investment decisions should be made in consultation with a financial advisor and only after reviewing relevant financial statements.]