XRX - Xerox: Unexciting Prospects

2023-09-28 14:04:22 ET

Summary

• Xerox's 1H 2023: anemic growth, but margins and bottom line improvement, seemingly largely due to temporary tailwinds and one-time benefits.
• Long-term prospects are unexciting as revenues and earnings are almost entirely dependent on the print industry, which is in secular decline and fitter competitors are eating into market share.
• It remains to be seen if their new growth initiatives could bear fruit, however limited differentiation against competitors suggests unappealing prospects at this point.

A dividend yield of over 6%, and price/book value of under 1 looks cheap, however I believe Xerox ( XRX ) appears cheap for a reason with unexciting long run prospects likely to result in capital losses long term.

Company Overview

Xerox is a document management solutions company. Products offered include printers, copiers, software solutions, managed print services, and cloud computing solutions.

The company has two operating and reportable segments

Print and Other: "engaged in the design, development and sale of document management systems, solutions, and services and associated technology offerings including IT and software products and services."

Financing (FITTLE): engaged in providing financing for the sales of Xerox equipment and non-Xerox office equipment.

Q2 2023 performance

For the second quarter ended June 2023, Xerox’s revenues were flat (up 0.4% YoY including a 1.2% contribution from an acquisition partially offset by a negative 0.1% currency impact). Net losses increased to $61 million from a $4 million loss the same quarter last year, however that included a $132 million expense related to Xerox’s PARC donation.

For 1H 2023, Xerox reported an anemic top-line growth of 1.5% YoY, reaching $3.469 billion. The company swung to profit of $10 million during the period compared with loss of $60 million the same period last year, however that included one-time benefits including Fuji Xerox royalty fees.

Both operating segments grew during the 1H 2023 period; Print & Other sales rose 1.3% and FITTLE revenues rose 4.6%.

Within the Print & Other segment, equipment sales rose 19% in 1H 2023 helping offset a decline in post-sale revenue (which reflects revenues from contractual print services, supplies and financing), a much bigger revenue stream, which dropped 2.8% YoY due to lower paper sales.

Management expects full-year 2023 revenues to be flat or down in constant currency terms but operating income and margins are expected to be higher than 2022 due to stronger-than-expected realization of operational efficiencies (partly helped by falling logistics costs due to improving supply chain conditions) and revenue mix.

Although Xerox’s operating performance appears to be improving, much of this is likely due to short-term post-pandemic tailwinds including a normalization of demand as workers return to office and moderating logistics costs due to improving supply chain bottlenecks. Looking further ahead, prospects are not optimistic; the print industry is in secular decline and in line with the industry’s decline, Xerox’s revenues have long been on a downward trajectory as well. Although revenues have been inching up post pandemic, they remain well below pre-pandemic levels and recent growth is likely due to an improvement in product availability due to improving supply chain conditions (particularly in North America, Xerox’s biggest market accounting for about 55% of the company’s revenues) as well as near term demand recovery as workers gradually return to office .

There is little reason to see a material improvement in the company’s fortunes; workers may be gradually returning to office, however hybrid working arrangements suggest in-office workers will comprise a smaller proportion of workers compared to pre-pandemic levels.

Meanwhile, the pandemic accelerated office digitization, and AI-based technologies could possibly further drive automation and paperless trends going forward thereby driving down printing usage. Additionally, competition is intensifying due to a shrinking market, with fitter competitors like Canon ( CAJPY ) and HP ( HPE ) eating into Xerox’s market share (Xerox held a 7% market share of the global printer market in 2015, which subsequently dropped to 5% two years later, and dropped to under 2% by 2019). Competitive pressures have not been helped by Fujifilm’s termination of their Fuji Xerox partnership in 2021 which turned the longtime allies into rivals.

Xerox has few avenues to counter falling sales as the sun sets on the print industry; the company is barely diversified with virtually all revenue streams centered around printers and related products and services.

Shrinking revenues and therefore shrinking funds for R&D suggests limited innovation and technological advancement which may make the company’s products less competitive longer term. Xerox’s R&D expenses of $304 million in FY2022 is about half of the $603 million spent on R&D a decade ago. For perspective printer market leader Canon’s R&D budget is over $2 billion, much of which is invested in their printing division which accounts for over 50% of revenues.

Strategic growth initiatives including the company’s offering around new tech trends like digital transformation and hybrid work have yet to bear fruit and it remains to be seen if they ever will. Xerox has a small customer base to work with relative to their bigger rivals like Canon , and HP. and those rivals also happen to have their own portfolio of products tailored to cater to digital transformation and hybrid work. Xerox’s product offering at this point appears to have limited differentiation in a space with no shortage of options.

Financials

Xerox is quite highly leveraged with a debt to equity of over 90. Their liquidity is adequate with a current ratio of 1.15 and a quick ratio of 0.81. Their dividend is so far well covered by free cash flows. Management projects free cash flows of at least $600 million and CAPEX is expected at $50 million. Dividend payments amounted to less than $200 million last year.

Conclusion

Xerox has a sell consensus rating on Wall Street.

Xerox’s share price has appreciated 13% this year, possibly reflecting the company’s improving near term financial performance. However, much of this is due to short term tailwinds i.e., post-pandemic demand normalization, easing supply chain constraints along with one-off benefits notably Fuji Xerox royalty fees. With Xerox’s core printing business in a sunset era, and fitter competitors eating into Xerox’s market share, the company’s medium term prospects are not exciting and further revenue erosion is likely. The company’s growth initiatives at this stage have yet to deliver fruit and given limited differentiation against fitter competitors like Canon and HP, it remains to be seen if those efforts could deliver material yields at all. With a price/book of under 1 and a dividend yield of over 6% that as of now seems secure, Xerox appears to be cheap, however unappealing long term prospects could impact their share price resulting in capital losses.

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