Xerox (XRX) was founded in 1906 as the Haloid Company; it was named Haloid Xerox in 1958 and Xerox Corporation in 1961. 2010 revenue was $22 billion, with 136,000 employees and a geographical scope extending to 160 countries.
Xerox’s financial performance is based on the following two primary reportable segments – Technology and Services.
The Technology segment includes the sale of document systems and supplies, technical services and product financing. The products range from:
- “Entry,” includes A4 devices and desktop printers; to
- “Mid-range,” includes A3 devices that generally serves workgroup environments in mid to large enterprises and includes products that fall into the following market categories: Color 41+ ppm priced at less than $100K and Light Production 91+ ppm priced at less than $100K; to
- “High-end,” includes production printing and publishing systems that generally serve the graphic communications marketplace and large enterprises.
The Services segment is comprised of three outsourcing service offerings:
- Document Outsourcing (which includes Managed Print Services)
- Business Process Outsourcing
- Information Technology Outsourcing
Service revenues more than doubled due to acquisitions in 2010 as shown below.
Before we get to the valuation, we’ll take a look at a few metrics. The first graph is a history of revenue vs. gross margin:
Revenue growth looks good but gross margins have been falling. Drilling down deeper reveals that in January 2011 management announced the business would operate in a gross margin range of 33% to 35% going forward. One reason is the change ! in produ ct mix. As noted above, the Services segment has more than doubled through acquisitions, accounting for the jump in revenues and lower gross margins.
Why? Projected 2012 gross margins for this segment are 23-25% while the technology clocks in at 44-46%. On a brighter note, the operating margins for Services are 11-13%, slightly higher than the Technology segment at 9-11%. 2012 revenue growth for the Services segment is projected to be substantially higher (6-8%) than the Technology segment (1-3%). Xerox is moving from a technology to a services oriented company. The drop in margins has more to do with the product mix vs. pricing pressure.
To provide more color going forward, management has provided the following guidance summarized below (source: Q2 Investor Handout):
Guidance | 2011 | 2012 |
Revenue growth | H2: 3-5% | 4-6% |
Operating Cash | $2.0-$2.3B | $2.6-$2.9B |
Capex | $0.5B | $0.6B |
Free Cash Flow |
| $2.0-$2.3B |
GAAP EPS | .91-.96 | NA |
Adjusted EPS | 1.07-1.12 | 1.18-1.28 |
Op. Cash Flow (% Revenue) | 9-10% | 11% |
Share repurchases (# shares) | 60-70m | 100m+ |
Management expects to generate over $10B of free cash flow over the next 5 years.
VALUATION
Here is one fair value view based on management’s financial track record focusing on the financials as they relate to fair value, followed by possible risks.
Fair values are based, in part, on the following: discounted cash flow, a modified Graham's intrinsic value formula and a P/E analysis. The valuation model consists of two parts.
- The discounted cash flow and the modified Graham’s intrinsic value are blended to arrive at a fair value.
- A P/E analysis based on historical adjusted values.
Fair value used is the minimum value of the two parts.
Part ! 1: Disco unted cash flow and the modified Graham’s intrinsic value.
Longer term earnings growth estimate:
Projections (for EPS and cash) are arrived at by calculating the statistics for a trend line using the "least squares" method. This determines the line that best fits the historical data. Projected earnings growth through 2016 averages about 2.6% based on a combination of the 10 and 5 year trends.
Analysts are much more optimistic for longer term earnings growth than our analysis, projecting 18% despite the graph depicting lower growth through 2014. (Source: nasdaq.com) We should note the below graph is as of September 23, 2011. A reason for the optimism could be the 2010 acquisitions.
Analyst consensus earnings growth projections:
The numbers we use are based on diluted GAAP earnings, not adjusted earnings. Management expects adjusted earnings in the range of 10%+ which takes into account share buybacks.
Longer term cash flow growth:
Projected long term cash flow growth calculations are 4%. This represents a weighting of the 3, 5, and 10 year trends using 2011 as the baseline. Our five year FCF totals approach managements $10B projection.
Estimated long-term EPS and cash flow growth rates going forward are 2.6% and 4%, respectively. Running these projections through our pricing model produces a fair value of $10. Needless to say, the result is sensitive to changes in these growth rates, as illustrated below.
XRX EPS & Cash Growth rates FV EPS-4.57%; Cash-6.00% $12.00 EPS-3.57%; Cash-5.00% $11.00 EPS-2.57%; Cash-4.00% $10.00 EPS-1.57%; Cash-3.00% $9.60 EPS-0.57%; Cash-2.00% $8.90 EPS-(0.43%); Cash-1.00% $7.40
Part 2: P/E Analysis
The pricing model produces a PE of 15.25 yielding a fair value of $13.4.
Final fair value is the minimum of the two methods or $10. The stock is trading at a 29% discount at the time of this writing. S&P has a 12 month target price of $14, Goldman Sachs-$11, Credit Suisse-$12, and the consensus median price on Yahoo Finance is $11.
Xerox pays a dividend of $0.17 yielding 2.39% based on a price of $7.11. The dividend represents a payout ratio to trailing twelve month free cash flow of approximately 17%.
Risk
The largest risk at this point is macroeconomic events that w! ould neg atively affect not only Xerox, but all financial markets. Uncertainty about current global economic conditions poses a risk as consumers and businesses may continue to postpone spending in response to tighter credit, unemployment, negative financial news and/or declines in income or asset values, which could have a material negative effect on demand for Xerox’s products and services.
A significant portion of revenues are generated from operations outside the United States. Future revenues, costs and results of operations could be significantly affected by changes in foreign currency exchange rates - particularly the Japanese yen to U.S. dollar and Japanese yen to euro exchange rates, as well as by a number of other factors, including changes in a country’s political conditions, trade protection measures, licensing requirements, local tax issues, capitalization and other related legal matters.
A summary of all financial details used in the analysis can be viewed here.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in XRX over the next 72 hours.
No comments:
Post a Comment