Barron’s Misses the Point on Xerox (XRX)

| About: Xerox Corporation (XRX)

We wrote about Xerox twice in the last couple of months (1, 2). This week’s Barron’s Magazine (full summary) takes a more positive look at the company’s prospects.

But the shares “look tempting,” the paper said in its May 1 issue, because it is trading at just 12.4 times analysts’ earnings estimates for next year, versus 17.5 times for rival Canon Inc. and 14.6 for Hewlett-Packard Co.

As Canon (ADR: CAJ) is not a US company, its financials are a bit harder to come by. But Hewlett Packard (NYSE:HPQ) does not share that issue. It posted cash from operations of more than $8 billion on $2.4 billion of net income. Importantly, cash from operations rose despite a decline in net income, which suggests the net income drop may indeed be temporary. Xerox, meanwhile, has seen two consecutive years in which cash from operations fell despite rising net income. For Xerox, the suggestion is that net income is not telling the whole story.

The company last week posted disappointing profits on slumping revenue, but Xerox’s fortunes have improved since it is paring debt, generating free cash, funding its pension plan, buying back shares and is likely heading toward an investment-grade credit rating, Barron’s said .
Management has indeed done a good job cutting debt, although it did issue more than $700 million of new debt earlier this year to fund its customer financing activities. However, its pension and other post-retirement benefits remain under-funded by $3.5 billion despite contributions of $500 million and strong investment returns in 2005. XRX is generating free cash, but less of it each year due to the sinking cash from operations. That said, it probably is strong enough to shed its junk rating in favor of an investment grade credit outlook.

The stock looks especially cheap if the first-quarter results are seen as a momentary slip in execution, the paper said. Xerox Chief Executive Anne Mulcahy said on a conference call after the results were released that she believes the company will be back on track in the second quarter, and will deliver improved margins, the paper said.

As Hemingway would say, “Isn’t it pretty to think so?” Unfortunately, the persistent cash flow declines suggest that this is a problem that has been festering for some time, not a one-quarter simple fix.