I keep finding two highly misleading bear arguments about Xerox (XRX) all over the web. I call them misleading because those who use them seem to have trouble understanding Xerox's fundamentals. Here are the arguments:
- The company has a huge load of debt.
- The company is stagnant and won't grow going forward
First I'd like to talk about Xerox's debt and a fact that many investors seems to miss. As you may know Xerox is selling all kinds of copying, printing and scanning equipment to businesses and consumers all around the world.
As you can read below, a third of all the equipment Xerox sells is sold under a leasing agreement. This means that customers "rent" the equipment for a period of time (usually several months or even years) after which they become owners.
(click to enlarge)
Xerox is using debt (among other things) to finance these agreements. Below you can see Xerox's debt broken down to Financing Debt and Core Debt.
There are two reasons that this distinction is important. First the cost of the financing debt (interest and everything else) is passed to the customer and is essentially free. Second the financing debt is backed by the contract between Xerox and the customer and the actual equipment. That means that it doesn't affect Xerox's financial strength except for losses from customers that default on their payments.
Leaving the financing debt aside Xerox's net debt (debt - cash) position is about $2 billion. It is 17% of Xerox's equity and equal to its free cash flow for 2012. That is quite the opposite of an overleveraged company don't you think?
Below is a table with Xerox's debt maturities (for the whole amount of its debt). As you can see even if the whole $8.4 billion where core debt, Xerox would have no problem either repaying it or servicing it. The amount that is set to mature every year is just half the company's free cash flow.
Now with the first point answered and the company financially secure lets move to the second one, growth. I addressed this issue somewhat in a previous article or mine, "Xerox: A High Quality Stock At A Dirt Cheap Valuation".
However I'd like to expand some more and explain the two main drivers behind Xerox's EPS growth. The first driver is the company's services segment. With the acquisition of ACS in 2010 Xerox begun its transformation from a commodity-type product manufacturer to a business-to-business services provider.
As this segment grows its share in Xerox's profits, the overall growth for the company will increase. And this process will only accelerate because the printer segment is declining consistently. I expect Xerox to achieve an average 3% to 7% growth rate for the next decade.
The second driver of growth for Xerox's EPS is its buyback program. Utilizing its massive free cash flow Xerox bought more than 10% of its own shares in 2012 and has committed to do the same in 2013.
As the company's cash flow grows and its number of shares declines it will become increasingly easier for the company to continue this course benefiting tremendously its long-term shareholders. I expect the buyback program to add to the company's EPS growth by an average 5% to 10% over the next decade.
Xerox has a strong and healthy balance sheet, has low debt and a lot of growth potential ahead. The company is highly likely to offer its investors an EPS growth rate between 7% to 17% over the next decade through organic growth and an extensive share buyback program.
I strongly believe that Xerox is ridiculously cheap at its current valuation of 8 times its forward earnings. For this reason I have bought shares of the company and intend to sell them at a P/E multiple of 12 or higher.
Disclosure: I am long XRX.