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It's spreading like wildflowers -- Samuel Goldwyn

Eastman Kodak Disappoints
September 16, 1997

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You might call EASTMAN KODAK (NYSE: EK) the boy who cried "Wolf!" -- but it would probably be more accurate to see it as the boy who cried "Lamb!" The company has made a habit of promising extravagant returns from restructuring while delivering very little. After market close yesterday, Kodak once again disappointed when it announced that it would miss third-quarter estimates by a significant margin. Sales and earnings for the quarter would actually be lower than they were a year ago. The company added that 1997 earnings could be as much as 25% below consensus earnings estimates of $4.50 a share. The surprise announcement sent investors overboard, with the stock dropping ten points from its Monday close.

Unsurprisingly, the announcement was accompanied by a statement from Kodak CEO George Fisher promising "a significant reduction in the company's cost structure." Kodak President David Carp told The New York Times that Kodak was considering divesting certain product lines and cutting jobs. Neither Fisher nor Carp provided any real specifics, which makes it difficult to avoid the conclusion that Kodak is once again committing itself to reinvention without a real sense of what it intends to do.

Some of the company's troubles in this quarter have been out of its control, most notably the impact of the strong dollar. Kodak said that sales in the first half of 1997 -- when the company reported earnings per share of $1.94 -- were cut by $200 million, and suggested that if the dollar remains strong throughout the rest of the year, it could cost the company as much as 45 cents a share in earnings. The strong dollar has had a similar impact on the earnings of other large U.S. multinationals, and has contributed to recent anxieties about the performance of consumer stalwarts like Gillette and Coca-Cola. By making American goods more expensive abroad and foreign goods cheaper at home, the strong dollar hits certain multinationals coming and going.

Kodak's real problems have more to do with a price war at home and what appears to be a profound level of institutional inertia. Kodak now controls somewhere between 65-70% of the wholesale film market in North America, down from 75% just three years ago. The company is losing 1% to 2% of its market share every year to its only real competitor, FUJI PHOTO FILM (Nasdaq: FUJIY), and those losses may be accelerating as a result of Fuji's recent price cuts. Just last month, Fuji's Ted McGrath told analysts that the company was not embarking on a price war, insisting that the price reductions had occurred were the result of retailers getting rid of excess inventory. But in many places Fuji's prices, traditionally 10% to 15% below Kodak's, were discounted as much as 30% to Kodak, which suggests that something like a concerted scheme to garner market share was in effect. Fuji has also been assisted by the strong dollar that today buys more yen than it has, on average, in the last two years. In terms of dollar prices, the company can sell at a lower price point, convert those dollars back to yen, and not experience a falloff in revenues.

At the time, Kodak seemed more than content to accept McGrath's denials. But yesterday the company said the price cuts had put a major dent in quarterly earnings. More troubling, though, Kodak gave no hint of a real strategy to compete with Fuji. Carp said simply that he didn't believe Fuji could sustain the price cuts on a long-term basis and that Kodak could maintain market share by offering more value. Carp's comments can be seen as emblematic of Kodak's fundamental attitude toward the film market, which is one that emphasizes the authority of its brand name over more mundane matters like cost control or manufacturing efficiency. Earlier this summer, for example, Fisher dismissed the possibility that HEWLETT-PACKARD (NYSE: HWP) could command a sizable portion of the nascent digital photography market by saying, "People know what a Kodak moment is, but an HP moment? I don't think so."

Fisher's reliance on the aura of the Kodak moment, though, has undoubtedly hindered his attempts to reinvigorate the company. When Fisher first took over Kodak, he did a solid job of ridding it of the non-core businesses that had been acquired during the period of "diworsification," spinning off Eastman Chemical and selling Sterling Winthrop Drug to SmithKline Beecham. Initially, the results were impressive. Where earnings had been just 4% of sales in 1992 and 1993, they rose to 6.1% in 1994 and were above 8% in 1995. Investors responded as well, and Kodak's stock enjoyed solid returns in both 1995 and 1996. Nonetheless, the paring away of the non-photography businesses did not translate into a clear focus for the company as a whole, nor did it provide a simple recipe for tapping what may very well be a mature market. Like most consumer multinationals, Kodak has looked abroad for future earnings growth, but it's not clear that the "one extra Coke for every person in China" strategy has a clear equivalent in the photography market.

The company has invested heavily in digital photography, but so far the results have not been overly impressive. More importantly, the Kodak name does not -- Fisher's comments notwithstanding -- have the same power in the digital market as in the traditional film market. And all indications are that Hewlett-Packard and CANON (Nasdaq: CANNY) will be fierce competitors. Although having an established brand certainly makes it easier to enter into new, related markets, assuming that the clout of that brand will completely unseat any rival is irrational.

Kodak's balance sheet does remain strong, with a low debt-to-equity ratio and $1.8 billion in cash on hand. However, this is the third straight quarter that Kodak has announced disappointing earnings, and if the projections of $3.38 EPS in 1997 are accurate, the second half of the year will see Kodak's income decline by 18%. The company has been promising $4.00 in EPS for years now, and investors are beginning to wonder if it can be done with this management team. Ironically, Goldman Sachs raised its recommendation on the company to a "buy" just two weeks ago and projected 1998 earnings at $4.90 per share. But unless Fisher is able to pull a rabbit out of his hat, Kodak will be lucky to turn in earnings of $4.00 a share next year. Given the fact that the company trades at a multiple of 17 times trailing earnings and that it has proven more adept at promising change than making it happen, this is one Dog of the Dow that should be allowed to keep barking.

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