Razor Maker Still Has an Edge; Lots of Black Ink for Lexmark

Stock Exchange lets readers listen in as staff writers James Peltz and Michael Hiltzik debate the merits of individual stocks.

Gillette (G)

Jim: When it comes to shaving, Mike, I thought Gillette’s Sensor razor worked just fine. But Gillette keeps reinventing the wheel and that’s why it’s recently introduced the Mach 3 as its new flagship razor. Have I mixed enough metaphors yet?

Mike: Just a few. I own a Mach 3, by the way. It has three blades instead of two, so you know what that means?

Jim: What?

Mike: It means that when I nick myself shaving I get three cuts instead of two. Technology is a remarkable thing.

Jim: Gillette, of course, is the epitome of that oft-used axiom about the key to success in business being to “give away the razor and sell the blades.” And now it’s more true than ever because the Mach 3’s blades are even pricier than the Sensor’s.

Mike: Yeah, except Gillette took it one step further and sells the razor for an exorbitant price too.

Jim: Even so, the Mach 3 has been a big hit, and Gillette now commands an incredible 70% of the shaver market.

Mike: Gillette also makes other products under the same principle. It’s got Duracell batteries, which wear out and have to be replaced; Right Guard deodorant, which runs out and has to be replaced; PaperMate and Parker pens, whose cartridges need replacing. Are you getting the theme here?

Jim: It also sells Oral-B toothbrushes and assorted dental-hygiene items . . .

Mike: Which wear out and have to be replaced.

Jim: . . . along with Braun shavers and other personal-care gadgets.

Mike: Now what about the stock?

Jim: Gillette was the quintessential blue-chip growth stock for most of the ‘90s. I mean, its earnings kept growing at a double-digit pace year after year, and the stock kept moving ever higher, creating billions of dollars in stockholder wealth during the decade. You bought this stock and then relaxed in the deep clover.

Mike: Until last year.

Jim: Right. Gillette gets a whopping 70% or so of its $10 billion in annual sales from overseas, and that exposure killed them. The lousy economies in Asia, Latin America and elsewhere snapped Gillette’s string of big earnings gains. And the stock, which always carried a very rich price-to-earnings multiple, simply got hammered.

Mike: The stock did attempt a comeback early this year, but it largely fizzled because Gillette still isn’t out of the woods yet. But I have a question for those investors who ran for the hills: Are you nuts?

Jim: You mean you’d buy Gillette?

Mike: Absolutely.

Jim: Me too. Gillette’s international results will slowly get better, despite the company’s announcement last week that it’s still struggling overseas and that its second-quarter earnings will again come up short of expectations.

Mike: Which knocked its stock down a few more pegs, to the low40s.

Jim: Right. But I think Gillette will start bouncing back in the second half of the year, and I’d take advantage of the stock selling at these relatively low levels.

Mike: I’d also want to be a stockholder now because I expect Gillette to bounce back quickly. In fact, I’d love to have a portfolio of Gillette clones. It’s a master at profitably selling people something that wears out faster than they think it will. And with the Mach 3, Gillette has taken that skill to a new level.

Jim: Small wonder that billionaire Warren Buffett, through his Berkshire Hathaway Inc., is a big Gillette holder with a 9% stake. In fact, Buffett once was quoted as saying he sleeps better at night knowing that hair is growing on the faces of billions of men and on women’s legs around the world.

Mike: Another remarkable aspect of Gillette is its marketing power. You know, the Mach 3 didn’t get great reviews at first, but it was a big hit anyway because of millions Gillette poured into its promotion.

Jim: Gillette spent more than $1 billion to develop and market the Mach 3, but it looks like money well spent. And don’t forget: Gillette is just now rolling out the Mach 3 around the world, where, as I said, the company does most of its business.

Mike: And if I were a holder of Gillette, I’d also be waiting for the moment it announces the four-blade razor because it inevitably will, and Gillette’s stock will be off to the races again.

Jim: Yeah, maybe then I’ll trade in my Sensor.

Lexmark International Group (LXK)

Jim: Lexmark, which makes laser and inkjet printers for computers, used to be a printer division of International Business Machines, remember?

Mike: In fact, Lexmark just might be the best example of a company that needed to be cast out of the nest in order to thrive. It now has about $3 billion in annual sales, half of that in foreign markets.

Jim: This outfit, which is based in Lexington, Ky., left IBM in 1991 when it was sold to an investment bank. Lexmark later went public in ‘95, and ever since both the company and the stock have been stellar performers.

Mike: That’s almost putting it too mildly, Jim. The stock has more than doubled in just the last year, and it’s skyrocketed sevenfold during the last four years.

Jim: When I look at Lexmark the first thing I notice is that its profits--and its profit margins--keep swelling even though it’s selling products that are constantly falling in price. That’s quite an achievement.

Mike: That’s right, though it might be a little misleading to say its products keep falling in price. It’s more like Lexmark keeps throwing new features on its printers and selling them at the old prices.

Jim: But Lexmark also has been moving into lower-price markets. For instance, it’s making a big push in the under-$200 printer market. And as we’ve discussed before with CompUSA and others, that low end of the personal-computer market is a tough place to keep turning higher profits.

Mike: But Lexmark also is starting to divorce itself from that particular strain of the retail market by selling its products directly to consumers via the Internet.

Jim: Like Dell Computer and Gateway.

Mike: That’s right, and the way Compaq Computer would if it knew what it was doing. Anyway, that maneuver will give Lexmark and its stock another boost.

Jim: To emphasize my point about its earnings growth, check out this year’s first quarter, when Lexmark’s revenue rose 17%, but its profit surged 37% from a year earlier.

Mike: And its gross margins have reflected that. They’ve gone from a little less than 30% in 1994 to 36% and higher last year.

Jim: Which means it’s earning 36 cents for every dollar of sales before taxes, interest costs and the like.

Mike: Right. And it’s also close to earning nearly 50 cents for every dollar of its stockholders’ equity in the firm, which is double its level of a few years ago.

Jim: Well, I’d buy Lexmark without blinking. The company’s products are in big demand, management clearly has a cost structure that generates earnings growth, it has a strong balance sheet and it’s going into new, promising channels like the Internet. That’s a pretty good combination.

Mike: I agree. This is a company that’s proved to be a very powerful competitor to two 600-pound gorillas in this market, Hewlett-Packard and Xerox.

Jim: Whose stocks haven’t come close to matching Lexmark’s gains, I might note.

Mike: I go back to the fact that Lexmark was spun off from a bigger company. It had to sink or swim as a small company with a limited product line, and I think that accounts in large part for why it’s been able to out-duel Hewlett-Packard and Xerox because we know that one of their big faults is that they’re large, stodgy bureaucracies.

Jim: After its big gain over the last year, Lexmark just split 2 for 1, and now trades in the high 60s. Yet it still sells for only 31 times its expected ’99 earnings per share, which I think leaves plenty of room for the stock to go higher.

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Write or e-mail with a stock you would like to see discussed in this column. Times staff writer James Peltz (james.peltz@latimes.com) covers the markets and corporate financial trends. Times staff writer Michael Hiltzik (michael.hiltzik@latimes.com) covers technology and entertainment and is the author of the new book “Dealers of Lightning: Xerox PARC and the Dawn of the Computer Age.” Either can also be reached at Business Section, Times Mirror Square, Los Angeles, CA 90053.

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You can hear a preview of Peltz and Hiltzik’s weekly column Mondays on the KFWB-Los Angeles Times Noon Business Hour on KFWB-AM (980).

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Gillette

Monday: $42.38

Lexmark

Monday: $69.56