Lexmark (LXK), a manufacturer and supplier of printers, has seen its revenue decrease for the last four years, as stronger competition has forced it to reduce prices and exit now unprofitable product lines. While a string of revenue reductions of this nature may send most investors to the exit, value investors recognize that the business may still have some value, and thus prefer to first compare a company’s price with its value before determining a course of action. 

Lexmark trades with a market cap of $1.3 billion, despite the fact that it has around $800 million of cash on its balance sheet. A healthy dose of cost-cutting in the first quarter of 2009 resulted in operating income of $75 million off of a sales decline of 20%. With its strong cash position and its P/E of just 7.5 in this depressed earnings environment, Lexmark would appear to have value potential on the surface.
But as we discussed earlier this year, companies with defined benefit pension plans will be negatively affected by the stock market’s drop. Prudent investors who read the notes to the financial statements will see that Lexmark is indeed suffering from this phenomenon: pension plan assets fell last year from $714 million to $469 million, against an estimated pension obligation of $734 million. This represents a shortfall of $265 million, a cash outflow which will eventually have to be borne by shareholders (barring a miraculous stock market recovery, which of course is never safe to assume).
When Lexmark’s pension shortfall is combined with its debt obligation of $650 million, its value potential is no longer as certain. While it might still be a buy, investors who don’t consider all of this company’s obligations are likely to overvalue its intrinsic value
Disclosure: None