Markets & Finance

Photo and Imaging Prospects: Big Negatives


By Richard Stice, CFA Many industries have suffered from the economic slowdown, but the photography and imaging sector has been hit particularly hard. Corporations have become much more cautious with respect to the allocation of their IT budgets, and only those areas of technology deemed most critical are being fully funded. More specifically, spending on items related to data storage and replication has become a primary focus, while expenditures for products such as copiers and printers are being put off until the budding economic recovery picks up steam.

On the consumer side, many people have cut back on their vacation travel because of heightened delays and safety concerns following September 11, which means fewer camera and film purchases for holiday snapshots. Furthermore, corporate layoffs have been on the rise, which has dampened consumers' confidence and spending on photography products.

The photography and imaging sector also has been hurt by a strong U.S. dollar, which has hindered overseas sales. S&P's outlook for this sector continues to be negative, considering the lack of a catalyst to propel it out of this quagmire in the near term. As a result, S&P recently downgraded two stocks in this sector: Eastman Kodak (EK) and Electronics For Imaging (EFII).

MISSING THE DIGITAL WAVE. Eastman Kodak is once again attempting to streamline its operations. In November, 2001, Kodak implemented a new business strategy to position itself for profitable long-term growth. The goal is to allow business units to become more cohesive, while enabling resources to flow to the product groups with the best opportunities for profitable growth. This move comes on the heels of other restructuring initiatives undertaken in 2001 related to asset writedowns and headcount reductions.

Kodak's recent actions show that it has been facing an increasingly challenging photography market. The economic climate has severely hindered product demand, causing total revenues to fall in each of the last two years. Moreover, the company's latest outlook indicates that further sales declines are possible in 2002.

Kodak's problems are not solely due to the economic recession, however. The company has been slow to react to the growing shift toward digital photography. In fact, Kodak now predicts that its digital unit will not become profitable until at least 2003. Compounding this delay is the likelihood that digital photography will soon begin to cannibalize the sale of traditional film and processing services, areas that Kodak depends on for the bulk of its revenues.

DEPRESSED SHARES. Kodak is also facing challenges in its traditional product lines since competitors have gained market share through price cutting, which has resulted in shrinking margins. Finally, an additional layer of uncertainty surfaced in January, 2002, with the abrupt resignation of the company's president and chief operating officer after less than a year on the job.

As a result of its troubles, the company's shares have fallen over 20% in the last year. Although Kodak reaffirmed on Mar. 14 its full-year earnings-per-share range of $2.00 to $2.60, S&P believes its turnaround assumptions are too aggressive, and that the company may lower its outlook in coming quarters. Given the ongoing risks and ambiguity surrounding the company, S&P has placed a 1-STAR ranking -- a sell recommendation -- on the shares and would advise investors to look elsewhere for profitable opportunities.

Electronics for Imaging offers hardware and software products that enable users to produce color documents quickly and cost-effectively. The company developed its Fiery Color Server to optimize color printing on networks. Variations of the Fiery Color Server have also been introduced, with more than 100,000 units installed worldwide. Products are sold through distribution partnerships with top-tier color-copier makers, including Canon, Epson, Sharp, Toshiba, and Xerox.

PREMIUM VALUATION. Electronics for Imaging shares are well below their high of $69, as the challenging economic conditions have significantly reduced demand in the printer market. Moreover, visibility remains poor, with little if any indication as to when a meaningful turnaround may begin.

In addition to the macroeconomic factors, S&P is concerned with the company's lack of a diversified revenue base. In 2000, only three customers accounted for 70% of total revenues. From a valuation standpoint, the shares trade at roughly 43 times S&P's 2002 EPS estimate of $0.40, which represents a premium on its peer group, the broader market, and its historical average. Given these factors, S&P recently lowered its ranking on Electronics for Imaging to 2-STARS, or avoid, the expectation being that it will underperform the broader market over the next 6 months to a year. Analyst Stice follows photography and imaging stocks for Standard & Poor's


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