The technology industry has experienced erratic developments over the past few years which have forced the companies to introduce new ideas, either associated with product innovation or with the transformation of the company's business model. The technology hardware industry has also experienced similar circumstances. Similarly, many global companies have experienced adverse circumstances in Europe which have limited their top line growth as they turn to expense cuts to produce profitability. In this scenario, Xerox Corp. (XRX) has adapted a change in strategy as the revenue profile has shifted emphasis from products to services. This development occurred because Xerox was also unable to witness any strong prospects within US despite the relative stability of the economic conditions in the region. For the current fiscal year, flat revenues are expected but a considerable increase in EPS is likely to occur.
Revenue Profile And Stock Performance
As stated before, the company's major portion of revenues are coming from the services segment due to a decline in the performance of products like printers and copiers. The company pursued some strategic transformations in FY09, which included the acquisition of Affiliated Computer Services Inc. (ACS).
The above chart shows the revenue profile of the company with respect to business segments and regions. The document technology segment has been shrunk to become the second largest contributor to the revenues of the company but it still forms a strong proportion of total revenues. On the other hand, most of the company's revenues are coming from US and exposure to markets other than US and Europe is relatively small.
The above chart shows the performance of the company's stock as compared to the S&P 500 index since the beginning of the current fiscal year. The chart shows that the market has responded positively to the changes in the business model conducted by the company and the confidence in the management of the company has improved over this period. This is reflected in the stock price as the appreciation of the company's stock in the reference period is almost double that of the overall market.
Comparative Financial Performance
Over the past few years, the company's stock price as compared to its peers has remained at par. Most of the players in the overall industry have underperformed. Accenture (ACN) appears to be amongst the few players that have shown strong stock price appreciation. The financial performance behind the stock price movements will provide a better insight into the matter.
The above chart shows the change in diluted EPS of Xerox Corp. as compared to Accenture, Hewlett Packard (HPQ) and Canon (CAJ) since the beginning of FY11. The chart clearly shows that over this period, Xerox and Accenture are the only two companies which have shown earnings growth whereas the earnings have declined for the other two competitors.
The overall industry operates at weak margins as the growth in this sub industry has been overcome by the newer technologies. As a consequence, the revenues of information technology services industry have shown an average three year growth of 5% and average net income over this period has actually declined by 5%. At the same time, Xerox has reported corresponding average revenue growth of 13.8% and average net income growth of 35.1%. Despite the stagnation in revenues expected this year, the company's business model reflects promising prospects over the long term.
Comparative Valuation and Risk
In order to establish the company's position in the industry and understand the potential of the stock, a comparative valuation analysis has been conducted using some key valuation indicators.
Data Source: Morningstar
The above table shows the valuation metrics of Xerox, its competitors and the overall industry. We see that the company appears to be undervalued against its competitors and the overall industry across all valuation metrics. At the same time, the company offers a very decent dividend yield of 2.1%. This allows for a very strong upside potential. Accenture on the other hand appears to be overpriced across most valuation metrics which has limited the prospects of stock price appreciation. Xerox is also subject to some serious risk factors such as the high degree of competition in the industry. Also, the execution of the shift in business model appears to be smooth as yet but if the stagnation in revenues persists, the earnings growth will not be sustainable.
The management of Xerox has done a decent job in creating a strong business over the years. The growth of the company has been pursued through strategic acquisitions. In the near term, the top line growth is expected to stagnate but in the long run, the company is projecting a promising picture. The undervaluation of the company also favors the upside potential of the company. Keeping these factors in view, a buy recommendation is proposed for long-run investors as the stock is at a decent buying position at current price levels. The profitability of the company will eventually be reflected in the stock price, resulting in decent gains for the investors.