Xerox Corp. (XRX), the provider of printers and business services, fell the most in more than 20 months after giving earnings forecasts that trailed some analysts' estimates as Europe weakens...The earnings forecast "is a bit softer than hoped for," Ananda Baruah, an analyst at New York-based Brean Murray Carret & Co., said in a note to clients. ["Xerox Drops After Low End of 2012 Forecast Trails Estimates," Bloomberg, January 25, 2012.]
Indeed, the stock fell 9.9% on Thursday after announcing fourth quarter earnings (pdf). XRX has stayed stagnant since then, closing Monday at $7.73. Fourth quarter results met expectations, but Wall Street was disappointed in the company's guidance for 2012: GAAP earnings between 97 cents and $1.03 per share, with adjusted earnings per share expected between $1.12 and $1.18. That low level of projected earnings growth -- about 11% at the GAAP midpoint, 6.5% non-GAAP -- is apparently what led to stock's sharp decline.
The question investors should be asking is, who on Earth would be surprised by this? The stock is trading at 8.6 trailing GAAP earnings, and 7.2 times adjusted earnings. Even before the earnings miss, XRX had a single-digit P/E by any measurement. That low multiple was supposedly due to -- wait for it -- the company's slow level of growth. As such, the sharp move downward on slightly lowered growth forecasts seems unreasonable.
Xerox is what it is -- and the stock's move down over the past few sessions has made "what it is" more attractive. The balance sheet is a bit heavy -- long-term debt is $8.6 billion, about 80% of market cap, with total long-term liabilities net of cash about 16% over the company's market value. Earnings growth is unspectacular, at best.
The company's Services division now outsells its legacy copier and printer products, but margins were compressed in 2011 by weakness in Europe, an issue the company expects to continue in 2012. Its dividend yield of 2.2% offers a higher rate than the 10-year Treasury bill, but remains lower than many other large-cap US equities.
But Xerox is also trading below its book value and at less than seven times forward adjusted earnings. The company generates tremendous cash; levered cash flow from 2009-2011 (defined as operating cash flow less capital expenditures and interest costs) was over $4 billion, about 40% of the company's market capitalization. In its fourth quarter conference call, the company guided for 2012 free cash flow of $1.5 to $1.8 billion, putting levered cash flow in the range of $1.15 to $1.5 billion, depending on interest costs and the company's ability to pay down debt. If the company meets guidance, it will be the fourth consecutive year that the company has generated over a billion dollars in cash:
XRX Levered Cash Flow, 2009-2012
|Year||Levered Cash Flow||% of Market Cap|
Data from company reports and SEC filings; market cap is $10.33B based on Monday's close of $7.73 and share count from Q4 earnings; may differ from other public data
1 At midpoint of company guidance for free cash flow of $1.5-$1.8 billion (based on $2.0-$2.3 billion in operating cash flow, less $500MM in capital expenditures), less 2011 interest expense of $328 million. Company is not guiding to lower net debt in 2012.
On average, from 2009 to 2012, the company's levered cash flow yield will be 13.9%, an excellent return in any market. The company plans to use the cash generated in 2012 for minor acquisitions -- hoping to create a little more growth -- and to buy back roughly $1 billion in stock, nearly 10% of shares outstanding.
The "bit softer" earnings forecast does little to change the bull forecast for XRX. (And those earnings were, actually, just a bit softer; the company's guided range for adjusted earnings of $1.12-$1.18 came in against an analyst consensus of $1.16 for 2012, according to Barron's.)
Xerox is not a growth play; it is a long-term value play. The company must continue to manage its expenses, must continue to create modest top-line growth (total revenue in 2011 rose 5%), and must continue to create substantial cost savings from restructuring and synergy gains, which totaled $400MM in 2011, according to the Q4 earnings presentation (pdf).
If the company can successfully stay on that path, it will continue to successfully generate tremendous amounts of cash. And if Xerox continues to generate over a billion dollars annually, patient, long-term investors will be rewarded. European weakness and short-term margin troubles simply don't change that thesis, but the 10% drop in the stock in response to those problems provides an even stronger entry point.