Kodak: Not Enough Positive Development?

Its shares are off their lows, but long term question marks over its transition to a digital world linger

By Amy Tsao

Investors, optimistic that the economy is improving and buoyed by news of another restructuring, have boosted Eastman Kodak's (EK ) stock recently. Shares have risen to about $30, from a 52-week low of just over $24 per share two weeks ago. UBS Warburg analyst Ben Reitzes, who hasn't been bullish on the stock since early 1999, recently upgraded his rating on Kodak shares to buy from hold. He expects them to rise 20% in the near term, as the company's cost-saving efforts start to pay off early next year.

Perhaps. But investors should proceed cautiously. It's troubling to many that Kodak has suffered credit downgrades and has had to slash its earnings guidance for the last quarter of this year -- from a consensus estimate of $0.46 per share to just $0.15 per share. That's a sign the company is being hurt by lower film sales caused in part by the sharp slowdown in travel and in the economy generally in the wake of the September 11 attacks. Adding to the woes is pricing pressure on Kodak's health-imaging business, which makes X-ray chemicals and film, as well as digital laser printers to process X-rays.

The recent upswing in the the Rochester (N.Y.) company's stock is partly due to the latest round of restructuring, which is meant to make business units more autonomous and more accountable for their own performance. Kodak now will be sectioned into five groups instead of seven. The core three will be photography, including professional and consumer photo; commercial imaging, including graphics and commercial printing; and components, such as the flat-panel display technology used in cell phones. Its health-imaging group and entertainment-imaging unit, which makes movie film, will remain.


  Kodak says the reorganization will augment the benefits of previously announced job cuts of up to 7,500, about 9% of its total workforce. Overall, the company aims to cut about $400 million out of its annual costs. "The ongoing benefits of a simpler model will start to be evident as we go into next year," says Pat Russo, chief operating officer and architect of the new plan.

However, Russo concedes that the move, one of several announced since Daniel Carp became CEO in January, 2000, isn't sure to cure what ails Kodak. "There's never any silver bullet when looking to improve performance," she says, though she contends that the moves leave the company "better positioned for managing the business coming out of the downturn."

Many on Wall Street remain skeptical. Eight of the nine analysts who cover the stock rate it a hold or lower. Merrill Lynch analyst Shannon Cross recently started coverage of Kodak stock with a reduce rating, noting that the stock is overvalued even at its current price-to-earnings ratio of 11 times estimated 2001 earnings. Cross thinks the stock is worth only about $22 per share.


  Even taking into account the recent restructuring, she forecasts earnings per share of $2.28 this year, down from $4.59 in 2000. And she believes things will be even worse next year: Her projection for earnings-per-share is just $1.47, even lower than the consensus forecast of $1.89.

Kodak remains No. 1 in the traditional film business. But long-term doubts about its future linger, as digital photography gradually encroaches on film. "Even if they do become a major [digital-photography] force, will they have as good margins?" asks Morningstar analyst David Kathman. Ed Lee, an analyst at Boston-based Lyra Research, predicts that Kodak "will be among the top five or six digital [photography] leaders in the next several years," but probably not No. 1 or No. 2 in the world.

For now, slumping growth is proving a challenge. Kodak's economically sensitive consumer-imaging business, which makes up more than half of its revenues, fell to $1.8 billion in third-quarter sales, off 8% from last year. Profits fell 45%. Analysts hoped a solid performance at the health-imaging business, which accounted for 17% of the company's third-quarter revenues, would save the day. It didn't: Profits slid 64% in the third quarter.


  In the future, Kodak hopes to offset such shortfalls by becoming a big player in digital photography. Its three-pronged strategy includes selling digital cameras and other digital equipment, providing the infrastructure for online technologies such as photo-sharing sites (America Online's "You've Got Pictures" and K-Mart's Bluelight.com), and selling digital photo services like Ofoto.com, which provides online picture storage, sharing, enhancing, and printing.

Carl Gustin, chief marketing officer for Kodak, predicts that such services will one day generate big money for the company. "We really don't have a problem trading traditional film [revenues] for digital [revenues]," he says. "The margins may be lower than film, but we'll get a lot more transactions in digital."

However, Kodak's digital transition is proving arduous. Its consumer digital efforts aren't generating much sales volume, Gustin admits. One problem is that broadband Internet connections haven't caught on widely enough yet. Online services such as Ofoto.com remain unprofitable. In general, many consumers still consider digital photography difficult and pricey. "It's a question of when the market's going to catch up," Gustin maintains.


  By the time the market does catch up, Kodak might be a lot smaller, analysts fret. The company is being challenged by a gaggle of competitors in traditional photography, including longtime rival Fuji and consumer-electronics companies like Sony. "[Kodak is] no longer on top of the heap," says Ray Cowen, assistant research director at Value Line. "Electronics companies are more used to the kind of competitive, cut-price situation [and lower profit margins] existing in digital. Kodak has to face that."

That's why many investors have trouble making a case for buying Kodak shares. "As a value-oriented buyer, it keeps squawking at me," says Eric Leo, chief investment officer at Allied Investment Advisors. "But I have to be convinced they have some strategy in place to survive and do reasonably well in a very competitive industry." For the moment, it looks like that evidence will be slow to develop.

Tsao covers the markets for BusinessWeek Online in New York

Edited by Thane Peterson

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