Kodak: Horrible Fundamentals But Too Cheap To Short

At first blush shares of Eastman Kodak (EK) appear to be an attractive candidate to short. Digital cameras have essentially eliminated the company’s largest and most profitable revenue generator (traditional film) and sales have been declining for years. Kodak’s answer to a disappearing business has been to focus on digital hardware such as their own camera line as well as a foray into the world of ink jet printers and cartridges. The glaring problem with this strategy is that they are shifting from a very high margin, uncompetitive area (film) to a very low margin, highly competitive one (consumer electronics). The results thus far have been predictably poor. Over the last five years EK stock has plunged from $30 to under $4 as sales have declined and profits have all but disappeared during what they dubbed a “digital transition.”

Since I really do not envision the fundamentals for Kodak improving, it is a prime choice to look into as a potential short candidate. After such a dramatic fall, however, coupled with 24% of the outstanding float already sold short, there does not appear to be much room to the downside, in the near term anyway. This is mainly because Kodak has managed to successfully clean up its balance sheet in recent years (an imperative when a business is in decline) to the point where they now have net cash (cash on hand less gross debt) of about $150 million. And while revenue is certainly declining, they still bring in about $7 billion a year in sales. Such figures make the current stock price ($3.75) and equity valuation ($1 billion) look reasonable enough that shorting now is not all that exciting to me.

Considering Kodak’s current equity value of $1 billion and revenue run rate of about $7 billion annually, the company only needs to earn a net profit equal to 1.4% of sales to earn $100 million annually, which would give the stock a P/E ratio of 10. Therefore, in order for a short position to work well at current prices, the P/E would have to drop far below 10, sales would need to fall off a cliff, or they would have to start to bleed cash. While the business fundamentals are poor, none of these scenarios seem like a high probability event in the near term. More likely, Kodak will continue to slowly lose revenue, run the business at break-even or slightly above, and the stock will trade at a discount based on their weakened market position. While these facts would not make Kodak stock a good investment at current prices, there does not seem to be a huge amount of downside either, barring some unforeseen event.

Full Disclosure: No position in Kodak at the time of writing, but positions may change at any time