Keep Holding DXC Technology

Summary

• DXC took a big goodwill write-down.
• Turnaround and transformation still a work in progress.
• Upside delayed by one to two quarters.
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DXC Technology (NYSE:DXC) rattled investor confidence when it announced a dividend suspension in its fourth-quarter earnings report. Selling volume surged beyond levels not seen since September 2019. At the time, DXC's stock was starting its descent from the $35.00 level. DXC is down around 5% since my last article here (link accessible by DIY Value and Seeking Alpha Premium subscribers). But the stock lost half its value since the February write-up.

With the previous 5.91% dividend yield wiped out, where do the company’s prospects stand?

Massive Write-down

DXC reported a $13.79 a share loss because it included $14.99 a share in goodwill. It also recognized impairment, restructuring costs, and integration-related costs. The 76 cents a share pension and OPEB actuarial and settlement gains helped offset those losses. The company returned $214 million in dividends and $736 million in share buybacks in the fiscal year. Poor customer delivery and weakening customer relationships cost the company around $1 billion in the year. The company expects to lose a similar amount this fiscal year. This is due to customers ending their business with DXC.

In the next six months, DXC will feel the impact of the lost business. Conversely, CEO Mike Salvino said on the conference call that “the good news is that this fundamental problem is absolutely within our control and fixable. In fact, we're making good progress on bringing the new DXC to our customers, which should help stem future revenue runoff.”

Calling the problem fixable is not good enough for investors. Management said that it would address its challenged account with better results. Though it fixed 35 of the 40 accounts, two customers are leaving DXC, and three are still unresolved. The poor results suggest that the company does not have a strong enough moat. Plus, it is too exposed to the most sensitive sectors suffering from a downturn. For example, the travel, transportation and hospitality, aerospace and defense, and consumer and retail sectors are struggling due to the impact of the coronavirus.

More Cost Cuts

DXC will cut its unnecessarily complex management layers. It expects to save $700 million annualized. It forecast $550 million in savings for this fiscal year (FY 2021). 3.5%, or 4,500 staff, will be laid off. Unfortunately, the HPE arbitration award and the $5 billion asset sale still do not cover the total debt of $9.9 billion, which includes capital leases. It has $8.67 billion of long-term debt on the balance sheet and over $5.5 billion in cash. DXC expects the sale of its U.S. state and local health and human services business to Veritas Capital to close at the end of the second quarter.

Despite these challenges, DXC reported cloud and security revenue growing 7% year-over-year. Book-to-bill was 1.1 times in Q4. For the full year, cloud and security revenue topped $42 billion.

Dividend Cut

DXC pulled Micro Focus' (MFGP) stock lower when it suspended its dividend. The CEO said that “the pause in the dividend will give our board an opportunity to reevaluate the appropriate dividend payout following the completion of our strategic alternatives.” In the near term, the already lowered product and services prices to keep its customers did not help. DXC expects the impact of COVID-19 on its project work will result in a revenue decline of 8% to 10% sequentially.

Data by YCharts

Above: DXC's dividend yield more than quadrupled, so markets correctly anticipated its suspension.

Below: DXC and MFGP are following the same downward path this year.

Data by YCharts

Investors who believe that the company needs more time to turn around the business may accumulate DXC's stock sometime in the next three months. The company is forecasting a low point in EPS in Q1. Higher investments will also weigh on results. DXC will stop offering price concessions, which hurt profit margins. And as it embraces the shift to cloud over on-premise systems, its business will improve.

Price Target and Your Takeaway

On Wall Street, analysts have a mixed opinion on DXC. The lowest price target is $13 while the highest is $33:

Source: TipRanks

DXC is an ongoing disappointment, but it has the leadership capability for cutting costs, dropping non-profitable customers, and dramatically improving customer service. Most importantly, the company will pay its more valuable staff. So, by retaining talented personnel and investing in the cloud and security unit, the stock will recover from last week’s drop.

Analyst’s Disclosure: I am/we are long MFGP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.