After writing a number of articles about Nokia (NOK), one reader approached me and asked me to take a look at Xerox (XRX), which may have a number of things in common with Nokia. After all, they are both companies once known to produce high-quality durable goods. While Nokia was the world leader in mobile phones, Xerox was one of the biggest companies in printers and copy machines, along with Hewlett Packard (HPQ) and a few others. During the dot-com bubble, the company's market value was as high as $70 billion, which is 10 times the amount it's at today. Today, while Xerox is still profitable, the company is having two troubles: high debt levels and declining revenue. The investors don't seem to think that Xerox will be successful anytime soon as the company has been trading at a very low P/E ratio for a while.
In the last five years, the average P/E ratio for Xerox was 19.1 while the highest P/E ratio was 63 and the lowest P/E ratio was 7.3. Interestingly enough, the company's current P/E ratio of 7.8 is very close to its five-year low (and possibly all time low).
In 2003, Xerox generated revenue of $15.70 billion. The next few years, the company's revenues remained pretty much flat year after year. In 2004, 2005 and 2006, the annual revenues for Xerox were $15.72 billion, $15.70 billion and $15.90 billion respectively. The next two years, the company was able to generate $17.23 billion and $17.61 billion respectively. When the recession hit, Xerox saw a revenue decline just like most companies in the world and it reported revenue of $15.18 billion in 2009. After the recession, the company has emerged stronger than ever and reported revenues of $21.63 billion and $22.62 billion in the next two years. In the first 3 quarters of 2012, Xerox generated $16.46 billion in sales with one more quarter to go. The company is expected to reach revenue figures between $22 billion and $23 billion for the current fiscal year. Keep in mind that Xerox currently has a market value of 8 billion, which is nearly one third of the yearly revenue it generates.
As for turning the revenues into earnings, the company hasn't been doing that great. Over the years, the annual earnings for Xerox have fluctuated greatly. For example, in 2001 the company reported a loss of 15 cents per share, followed by 2 cents of profit per share in the following year and 36 cents of profit in the next year. Between 2004 and 2008, the company's annual earnings ranged from 86 cents per share and $1.22 per share. During the recession of 2009, the company continued to be profitable but it was only able to generate 55 cents per share in earnings. After the recession, despite recording record revenues, it was only able to report earnings of 43 cents per share in 2010 and 90 cents per share in 2011. By the end of 2012, it is expected to earn less than 1 dollar per share for the year. This may not sound like much; however, the company trades for less than $7 per share at the moment.
Moving forward, the company is planning to see future growth by diversifying its portfolio of offerings. This is important because the market is getting very competitive and it is getting more difficult to gain market share when there are more companies fighting for it. Last year, the company increased the number of color printers it offers and penetrated deeper in the market of small and medium size businesses. Internationally, there is a lot of potential growth in smaller businesses who don't usually have long term commitment contracts with hardware providers and Xerox is well-positioned to take advantage of this opportunity.
Today, many businesses share documents electronically whereas there is less reliance on paper documents. Many analysts and investors think this is bad for companies like Xerox, but they forget that the company also offers products that help with creation, editing and distribution of digital documents. In an effort to increase its market share in business processes, Xerox acquired ACS for $6.4 billion in 2010. Now, ACS generates more than what it was acquired for in annual revenues.
Xerox generates a lot of cash flow in both hardware and services. In the last 3 years alone, the company's cash flow from operating activities totaled $6.8 billion, which is nearly as much as the company's market value. By 2017, the company expects tremendous growth in colored documents and business services whereas it expects a lot of shrinkage in black and white printing and the related hardware. The company plans to respond to the changing market by making declining items a smaller percentage of its overall portfolio offerings and making the growth oriented items a larger percentage of its total revenues.
In 2013, the company doesn't expect much revenue growth as it continues to focus on reorganization. The revenue of Xerox in 2013 is likely to be pretty flat compared to the company's 2012 revenues. This is not very bad because a lot of investors and analysts expect the company's revenues (and earnings) to fall dramatically in the near future. Generally speaking, when a company stops growing and becomes a value play, it will have a P/E ratio near 10. When a company is assigned to a P/E ratio well below 10, it is assumed that the company will actually get smaller as opposed to growing. In the short term, Xerox is likely to have a flat growth rate but in the medium and long term, the company should have decent growth, especially after the world economy gets in a growth mode. It is difficult for many international companies to post growth when half of the developed economies in the world are in recession.
Under optimal conditions, Xerox should have a P/E ratio around 11 or 12. On the other hand, the company has a lot of debt, $9.35 billion to be specific. Keep in mind that a large portion of this debt (i.e., $7.5 billion) is long term debt and the company will have no trouble servicing this debt with its current cash flow. Regardless, this will drag down the company's valuation a little bit. Because of this, I would expect the ideal P/E value of Xerox to be around 9 and 10 until the company gets rid of a significant portion of its debt. Between 2009 and 2011, the company did a good job of decreasing its total debt from $8.92 billion to $7.10 billion, but it took more debt in 2012.
Currently Xerox is committed to return some of its earnings to investors in the shape of dividends and share buybacks. In the last quarter, Xerox increased its buyback program's budget by another $1 billion and committed to increasing its dividend rate once more. In 2013, the company expects to spend $400 million in share buybacks and increase dividend rate by 35%. Many people will argue that the company should pay off debt before returning cash to shareholders, but as long as it can service its long term debt, there shouldn't be a problem.
So, back to the question of whether Xerox can be liked by the investors: I think the company can see a lot of appreciation in its value if it reduces the amount of debt it has and convinces the investors that it can post growth once the world economy gets back on track. I think these two items are pretty doable and it will be all about the investor sentiment once the company accomplishes these two tasks. In the short term, there might not be much potential in Xerox but in the long term, there has to be a lot of potential in this technology giant. I surely don't see Xerox being another Kodak. The company is on the right track, and it is surely not behind the curve as much as innovation goes.