Lexmark added to top pick live list at Citigroup

Citigroup is making a big call on Lexmark  adding the stock to their Top Picks Live list with a whopping $52 price target (prev. $41).

Firm notes that LXK moves to CIRA’s conviction Buy list for three reasons. First, they do not believe 2010 consensus EPS ests reflect 1) the margin leverage associated with a cyclical improvement in laser printer/supplies demand, 2) the margin benefit assoc with the ramp of the new inkjet architecture intro’d in 9/09, or 3) mgmt’s plans to reduce op ex by a further 3-5% this year. Second, the shares are extremely inexpensive on both P/E (<6X FY10 operating EPS excl $6 in net cash) and DCF. Third, the shares are not widely owned; indeed, the current short interest represents more than 4 days of avg daily volume.

Cyclical and Structural Margin Boosters — In addition to a cyclical rebound in laser margins during 2010, there are several structural margin boosters. First, the co’s new inkjet architecture, intro’d in Sept 2009, reduces lifetime manufacturing cost for LXK while giving the co access to higher-usage customers. Second, LXK continues to move R&D and back-office to lower cost locations.

These factors drive Citi’s revised 2010 EPS of $4.01 (+23% yoy) and 2011 EPS of $4.62 (+15% yoy), both of which are well above consensus. Moreover, they consider their estimates conservative on a number of fronts. For example, they are modeling inkjet operating margins down yoy in both FY10 and FY11 despite the cost benefits associated with the move to an entirely new architecture (specifically, a 4-5X reduction in print head costs over the life of the printer). In addition, Citi is not modeling laser margins back to past-cycle-peak through 2012.

Per Figure 1 below, LXK’s first yoy hardware growth in 4Q09 since 1Q05 bodes well for further share price appreciation as hardware placements lead to highly profitable supplies’ revenue in the future. LXK’s share price and hardware yoy revenue growth are highly correlated (correlation 0.82).