Printer manufacturer Lexmark International (LXK) said first-quarter quarter profit rose, beating expectations, helped by a 42 percent drop in inkjet printer sales.

You read that right. Since printer makers typically lose money on printers (hoping to make up for it in future sales of ink or toner) the fewer printers they sell in a given quarter, the more money they make.

Of course, if the model is working the lower sales today would translate into lower future profits, as the unsold printers will not require ink refills. Part of Lexmark’s current problem appears to be a decision by Best Buy (BBY) to at least temporarily eliminate Lexmark printers from their stores.

Lexmark still has lots of cash on the balance sheet and is now trading at a 12.3% free cash flow yield, which offers room for a decent return even if the company’s earnings decline over time. It remains, in my opinion, worth a look for value investors. However, it offers a bumpy ride - and I’d like to see it hold the 50 day moving average as evidence against the stock being a value trap.

Disclosure: At time of publication, William Trent has no position in the companies mentioned in this article.

My latest post is up at RealMoney.

In it, I extend yesterday’s observations about the hidden strength in durable goods orders to specific industries that might benefit. Among those industries were primary metals, computers and electronic products, and motor vehicles and parts.

These industries may prove to be a good starting point for further research.

My latest column is up at RealMoney. In it, I explain why I think the negative reaction to BMC Software’s (BMC) purchase of BladeLogic (BLOG) was overdone. In summary:

BladeLogic is growing nearly 40% annually, compared to just 5% expected growth in BMC next year. By my calculations, it increases BMC’s revenue growth rate by 180 basis points, which should have a significant impact on valuation models.

What’s more, I think there were signs that BMC’s growth was due to accelerate on its own. Deferred revenues had declined slightly over the past nine months, which can act as a drag on revenue growth in future periods. But license sales are up 13.5% so far this year, compared to total growth of less than 9%. Today’s license sales should increase future maintenance and service revenues.

Although the BladeLogic deal is expected to reduce BMC’s 2009 per share earnings by 10 or 11 cents, BMC’s estimates for 2009 had already risen by a similar amount. Effectively, the dilution from BladeLogic offsets BMC’s organic improvements for a year.

Meanwhile, BMC has generated more than $540 million in free cash flow over the last 12 months. Some of that is unsustainable, as it comes from collecting on financed receivables. However, I think the sustainable free cash flow is more than $400 million. That still amounts to a 6.5% free cash flow yield at a time when five-year Treasuries return a paltry 2.2%.

Alternatively, I think the stock can generate double-digit returns over the next few years by virtue of its growth, despite a potential reduction in valuation multiples.

Disclosure: William Trent has no financial position in the companies mentioned.

My latest column is up at RealMoney. Here is a summary:

Government economic reports can do more than just indicate the state of the economy. Since many of the reports include industry-level data, digging deeper in the reports can help investors find specific industries to consider more closely. For example, the Bureau of Labor Statistics, which prepares the PPI report, provides detailed information on an industry basis.

Since I wrote about the PPI data in September, the pricing power has shifted to some different industries. Therefore, I thought an update would be in order.

Some of the industries that look interesting are petroleum refineries, industrial gases, computers, computer storage devices, and line-haul railroads.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned.

In December I thought Lexmark (LXK) might be worth a look for value investors. That call is looking much better since Lexmark reported earnings this morning:

Fourth-quarter revenue was $1.31 billion, down 4 percent compared to revenue of $1.37 billion last year. Fourth-quarter GAAP earnings per share were $1.04. Earnings per share for the fourth quarter of 2007 would have been $1.29 excluding $0.25 per share for restructuring-related activities.

The $0.58 consensus estimate was blown away, and guidance of $0.80-$0.90 for the coming quarter (ex. restructuring charges) was also ahead of the $0.80 consensus. Since I originally recommended the stock, it is down 1.5%, but that compares favorably to the 8.7% decline in the S&P 500.

The following is a reprint of my December 12, 2007 RealMoney column

Printer manufacturer Lexmark, Inc. (LXK) started out this year at $73 and hasn’t looked back. Unfortunately, its motion has all been to the downside. Now less than half the stock it used to be, is it time to consider a nibble?

The stock is certainly cheap enough. Not only is it trading at a mere 12x expected earnings, $6.60 of the $34.50 current valuation is literally cash in the bank.

Over the last 12 months, Lexmark has brought in cash from operating activities totaling nearly $500 million and used less than $200 million for capital expenditures, resulting in free cash flow of $309 million and a FCF/Enterprise value yield of 11% - a very juicy premium to the current Treasury yield.

Of course, any juicy reward is bound to come with some risks, so let’s take a good hard look at those.

Second Fiddle

Even before Hewlett Packard’s (HPQ - Annual Report) recent resurgence, Lexmark was a distant runner-up in the printer business. Lexmark countered this position by forging an alliance with Dell (DELL) under which Lexmark makes all of the Dell-branded inkjet printers and half of their laser printers. Unfortunately for Lexmark, they inked that deal just in time for Dell to start its own tailspin.

Then, even if Hewlett Packard were to falter there are plenty of other competitors in the wings. First there are the traditional rivals like Seiko Epson (SEKE.Y) and Canon (CAJ), and Brother (BRTHY). Then, converging technologies have made competitors out of Ricoh (RICOY), Xerox (XRX), Samsung, and Kyocera Mita (KYO).

Declining Business

Everyone knows that obsolescence is a key risk for technology companies, and Lexmark is currently feeling the pain of the industry’s ongoing shift from inkjet to laser technology. I’ll let Lexmark explain it themselves (courtesy of the latest 10Q filing:)

Lexmark believes it is experiencing shrinkage in its installed base of inkjet products and an associated decline in end-user demand for inkjet supplies. The Company sees the potential for continued erosion in end-user inkjet supplies demand due to the reduction in inkjet hardware unit sales reflecting the Company’s decision to focus on more profitable printer placements, a mix shift between cartridges resulting in a higher percentage of moderate use cartridges and the weakness the Company is experiencing in its OEM business. Additionally, Lexmark expects to see continued declines in OEM unit sales, aggressive pricing and promotion activities in the inkjet and laser markets….

As the Company analyzes the situation, it sees the following:

• Some of its unit sales are not generating adequate lifetime profitability due to lower prices, higher costs and supplies usage below its model.
• Some markets and channels are on the low-end of the supplies generation distribution curve.
• Its business is too skewed to the low-end versus the market, resulting in lower supplies generation per unit.

Cheap Enough?If the risks haven’t sent you running for the hills, you are probably wondering whether the current share price is cheap enough to justify taking those risks. With the prospects for a decline in sales, earnings and cash flow being more than a distinct possibility, any price paid is going to have to be justified for a declining business.

The traditional valuation model says that value is equal to the cash flow in the coming year, divided by the difference between the company’s cost of capital and its growth rate. The 11% free cash flow yield I calculated above is a version of this model, and it provides the denominator in the equation: lexmark’s return, less its growth rate, should equal 11%.

Since the growth rate is negative, the return will be something less than 11%. If the current declines of approximately 3%, the implied return works out to 8%. That probably doesn’t sound like a huge payoff for many investors, but it is still a nice premium to Treasuries. Depending on the outlook for the rest of the market, value investors might find it worth a shot.

This article was originally published at RealMoney on September 26, 2007.

My article last week about mining the PPI report for stock ideas was so well received I thought I’d share another of my favorite taxpayer-provided idea generators, the durable goods report. Published by the U.S. Census Bureau, the report has a similar breakdown by industry of durable goods orders, shipments, inventories and backlog.  I came away with 28 potential ideas for further research.

In line with much of the recent economic data, the headline durable goods number was weaker than expected. To quote from the report, “New orders for manufactured durable goods in August decreased $11.3 billion or 4.9 percent to $219.5 billion, the U.S. Census Bureau announced today…. Shipments of manufactured durable goods in August, down two of the last three months, decreased $3.4 billion or 1.6 percent to $216.7 billion.”

But in this case, I think focusing on the forest means you could miss out on some of the more attractive trees. I gathered the data from the Census Bureau and created charts showing the year/year change in durable goods statistics for a variety of industries hoping to find some areas worth further consideration. Keep in mind, this is an initial screen for idea generation, not a full-fledged analysis of any of the names. You wouldn’t want to buy the stocks listed here without further research. That caveat aside, let’s look at some of the better performing industries.

First up is technology – computers and electronic products. Although 3.3% order growth year/year and essentially flat shipments may not be the type of growth investors typically look for from tech, it is a clear improvement from recent months. Inventories are starting to be drawn down and backlog remains strong.

But there are areas of strength and weakness within tech. Specifically, computers (and related products) themselves are starting to look strong, with backlog headed through the roof and inventories in check.

The fairly obvious stock ideas from this industry include Apple (AAPL), IBM (IBM - Annual Report) and Hewlett Packard (HPQ - Annual Report). If things keep getting better (and the company figures out how to file its required regulatory reports) Dell (DELL) might even look interesting again. Stretching a bit further, Sun Microsystems (a href="http://stockmarketbeat.com/blog1/category/tech/sunw/">SUNW - Annual Report) and Lexmark (LXK) come to mind. And don’t forget the storage plays, which also showed up on the PPI hotlist. The names I mentioned then were Brocade (BRCD), EMC (EMC - Annual Report), Iomega (IOM), Hutchinson (HTCH), Quantum (QTM), SanDisk (SNDK - Annual Report), Seagate (STX - Annual Report) and Western Digital (WDC).

Communications equipment is also showing some signs of strength. Though the latest month was down, the trend seems to be up.

I have actually analyzed Motorola (MOT - Annual Report), so that would be a play to include here. Cisco (CSCO), Research in Motion (RIMM), 3Com (COMS), Nokia (NOK) and Corning (GLW - Annual Report) also come to mind.

And finally, turning away from technology, I hope you didn’t think the aircraft boom was over. If anything, it looks to be picking up steam.

Ways to play this include Boeing (BA - Annual Report), Embraer (ERJ), General Dynamics (GD - Annual Report), United Industrial (UIC) and Cessna parent Textron (TXT). Parts suppliers include Rockwell Collins (COL), Curtiss Wright (CW - Annual Report), and LMI Aerospace (LMIA).

So there you have it: 28 potential stock ideas from what looked at first glance to be a negative report on durable goods.

Disclosure: Long RIMM put options at time of publication.

Key indicators for business spending include corporate profits and the cost of borrowing. Both have been favorable for years, yet businesses have focused more on cutting costs than on developing their infrastructure. With borrowing costs rising (at least in terms of the spread between Baa bonds and treasuries) I thought it another good opportunity to read the tea leaves from some recent conference calls.

Tech Data (TECD) starts things off on a positive note.

Looking at the Americas, our net sales exceeded our internal growth expectation which called for growth in the mid single digit range through strong execution and focused sales and product management efforts we want incremental business in the second quarter that boosted our growth rate to over 16% in the region, while still delivering our targeted operating margin. This double digit net sales growth was broad based with growth across virtually all of our product and customer segments….

Our Q3 business outlook calls for low double digit year-over-year growth in the Americas and flat to low single digit growth in Europe on the local currency basis.

(Excerpt from full TECD conference call transcript)

Staples (SPLS) is running into some tough spots.

Our North American retail business again experienced softer than expected sales during the quarter with same-store sales down 2% and total sales up 5%, which led to only a modest increase in the bottom line. Our North American delivery business continued to gain market share with top line growth of 16% and operating income of 18%. Finally, we’re happy with the strong improvement we’re seeing in our international business, where total sales were up 18% in U.S. dollars. That’s 11% in local currency. Same-store sales grew 7% and operating margin jumped 225 basis points to 1%.

So while we were very pleased with our results in North American delivery and international, it’s clear we’re operating in a tough retail environment in North America….

We had strong growth in copy center, laptop computers, ink and software, but these gains did not make up for negative comps in furniture, supplies, and tech durables.

(Excerpt from full SPLS conference call transcript)

And since both Staples and Tech Data source a good percentage of their tech products from Hewlett Packard (HPQ - Annual Report) it is important to get their take on the situation as well.

Moving to PSG, we shared an outstanding quarter with excellent revenue growth, market share gains in every region and strong margin performance. Revenue increased 29% year-over-year to $8.9 billion with unit shipments up 33% and double digit revenue in unit growth in every region. These results bring PSG’s year-to-date revenue growth to nearly $5 billion. We have a strong momentum driven by our notebook business which grew revenues 54%, and units 71% versus the prior year period. According to our estimates for the second calendar quarter, we increased HP’s notebook market share lead by over 5 points versus the prior year….

We now expect Q4 revenue to be approximately $27 billion to $27.2 billion, growing roughly 10% to 11% year-over-year. While the sequential increase of 6% to 7% implied by our guidance is less than the historical 10% to 12%, we do not believe it is prudent to set investor expectations that our Personal Systems business can continue to grow at almost three times the market rate, nor do we think it appropriate to build a cost structure on that basis.

(Excerpt from full HPQ conference call transcript)

There don’t seem to be too many signs of weakness, although the GDP numbers suggest there is. I’d argue for cautious optimism regarding tech spending over the next few quarters despite the rise in corporate interest spreads.

Cisco’s (CSCO) latest quarter was the talk of the town, and looking at the recent PPI data on telecom equipment (switchboard and switchgear apparatus) it should be no surprise.

The next fair question for any skeptical investor, of course, is whether the best ever pricing environment means things can only get worse. To gauge the market, I looked at some recent calls from a variety of telecom equipment makers.

Cisco doesn’t seem worried.

Although competition remains robust, we believe we are gaining market share versus almost all of our major competitors in most product categories. But we also believe we are getting a larger share of our customers’ total spend on communications and IT.

(Excerpt from full CSCO conference call transcript)

Nortel (NT) isn’t raising prices, but doesn’t seem to feel pressured.

I am very pleased we’re delivering measurable progress on margins. This is evidence of our processes and productivity improvements and, but also pricing discipline. And we’re bringing value with a great level of discussions. We’re improving productivity. Obviously we’re not increasing prices but there is a disciplined process and I think we’re demonstrating we’re able to deliver strong.

(Excerpt from full NT conference call transcript)

Juniper (JNPR), however, voiced some concern over competitors with “nothing but price to offer.”

Certainly demand is — as long as people continue to value their networks equal to or beyond what they have, which we believe they are, and then on top of that, they use them more than they did before. Every time something like the iPhone comes out, making it easier to put YouTube videos up and for people that demand higher bandwidth applications, that only adds to the demand curve. So there’s a lot of innovation going on in that space and all of it makes positive contribution to the infrastructure market.

Pricing is at it has always been — it’s always a challenge in a given case and clearly some of our competitors have nothing but price to offer. So we’re aware of that but I wouldn’t say that’s changed in the last couple of years, so probably not a big difference that I would note.

I do think what people can most easily judge the success of the company by is do we continue to gain in the markets that we serve? Do we continue to gain the market share and continue to improve the operating model of the company in the process and continue to grow the generation of our cash and the kind of things that we think make the business healthy and healthier today than it was yesterday and healthier tomorrow than it is today, so we’ll continue to push all those metrics.

(Excerpt from full JNPR conference call transcript)

Alcatel/Lucent (ALU) is already seeing pressure.

Our Q2, 2007 gross margin suggest difficult pricing environment, one that has been impacted in the short-term and not only our need to withstand some level of collective efforts by our competitors to unseed us our customers but, as well they — need occasionally to support some product migrations. Additionally for this transition year of 2007, we are strategically reinvesting the gross margin savings in selective markets to position the company for the long-term, while achieving most of our operating expense savings on a comparable basis.

In the second quarter gross margin was negatively effected by or negatively impacted by an unfavourable product in geographic mix, continued investments as I described and the impact of some product transitions cost as customers migrate their networks.

(Excerpt from full ALU conference call transcript)

All in all, it seems like a very company-specific environment, one in which it makes sense to stick with the leaders.

I recently looked at some of the enterprise software calls to get a check on tech spending. Today I take a look at hardware. The big (and most recent) news came from Cisco (CSCO):

Our balanced product momentum across our core technologies and advanced technologies continues to be the best I have seen in a number of quarters….
Let me approach it from a broad perspective. First is what we are seeing is the importance of balance on a global basis. I have been in this business for 30 years — Jim, I think you have been there that long or maybe a hair longer. It’s the strongest global economy I have been a part of.

(Excerpt from full CSCO conference call transcript)

It was funny that nobody challenged him on this, as anyone who has been in the business for long must surely remember Chambers’ comments in 2000. According to a CIO Magazine case study called “What Went Wrong at Cisco:”

Xilinx’s Wall Street warning came two months before Cisco Chief Strategy Officer Mike Volpi told The Wall Street Journal in November, “We haven’t seen any sign of a slowdown.” Volpi told The Journal that Cisco hadn’t changed its internal plans since the beginning of its fiscal year in August. “We have guided [Wall Street] accurately, and we can execute to plan.”
On Dec. 4, CEO Chambers crowed to analysts, “I have never been more optimistic about the future of our industry as a whole or of Cisco.”
Eleven days later, CIO Solvik says, the company saw the problem for the first time.

In case you were wondering, Xilinx (XLNX) lowered its guidance in June, then missed the lower estimate. However, they didn’t pin the blame on Cisco. On their call, they said:

During last quarters’ call, we forecasted that all geographies extension plan would be up sequentially. Japan was down sequentially as planned, but so was Europe, which turned out to be surprise. This quarter our top 10 European accounts, which represent 45% of total European sales were up 16%, but the main remaining channel accounts were down 19%. The weakness was mainly in the distribution channel across a few end markets including industrial, audio and video broadcast and data processing.

(Excerpt from full XLNX conference call transcript)

Turning to some other companies, EMC (EMC - Annual Report) is certainly having no trouble.

Looking quickly at the IT spending outlook for 2007, we see a positive environment in all major geographies and we believe there is opportunity for us to beat our annual financial targets for revenue, earnings per share and cash flow. EMC’s positive results and momentum are obviously only possible because customers are embracing our strategy, our leading products, our services and our solution sets at each of our four businesses — storage, content management and archiving, RSA security and VMware.

(Excerpt from full EMC conference call transcript)

Other tech companies aren’t so lucky. Sun (a href="http://stockmarketbeat.com/blog1/category/tech/sunw/">SUNW - Annual Report) said:

Sun’s total revenues for the fourth quarter of fiscal year 2007 were $3.835 billion, an increase of 0.2% as compared with $3.828 billion in revenue reported for the fourth quarter of fiscal year 2006.

(Excerpt from full SUNW conference call transcript)

The largest technology distributor, Ingram Micro (IM) had a mixed quarter - overall sales were reasonably strong but currency fluctuations played a big role:

On a regional basis, North America sales where $3.3 billion, essentially, flat versus the prior year or 40% of total revenues. As we described at last quarter warranty sales on behalf of our vendors are now recognized as net fees rather than gross revenues in cost of sales as reported in the prior year period. We saw a negative impact on year-over-year sales comparisons of approximately 5%. European sales were $2.78 billion or 34% of total revenues, an increase of 16% versus a year ago. The translation impact of relatively strong European currencies contributed an 8 percentage point positive impact on comparisons to the prior year.

Asia pacific sales were $1.76 billion, an increase of 31% over the prior year and 22% of our total sales. Finally Latin America sales were up 4% versus last year to $344 million representing 4% of our total sales.

(Excerpt from full IM conference call transcript)

Much like the software conference calls, the outlook appears reasonably positive. However, I’m not ready to break out the champagne and say were past the tech spending doldrums. Results are mixed, the financial sector is very important to tech spending, and Cisco’s forecasting track record doesn’t help my confidence level. While I’d love to see tech spending improve, I’ll have to see it to believe it.

Disclosure: Author is long IShares MSCI Japan Index (EWJ) at time of publication.