It's safe to say that the Haloid Photographic Co., founded in Rochester, N.Y, in 1906, is a long forgotten American technology name. Originally, the company manufactured photographic paper and equipment. We've all seen where that business has gone in the new digital age. Luckily, Haloid changed its name to Haloid Xerox in 1958 (dropping the "Haloid" by 1961) and developed a little product called the Xerox 914, the first plain paper photocopier.
There's no arguing the rock-star status of Xerox's (NYSE: XRX) brand. In fact, the word "Xerox" has become the generic reference to photocopying, regardless of what brand of copier you're using. The legendary 914 was even a guest star on AMC's uber-cool show "Mad Men," when the ad agency that serves as the setting for the series purchases the copier, and a hapless junior copywriter shares office space with the technological behemoth. The 914 is even an artifact in the Smithsonian.
But as you read this article on your smartphone or on your computer, you may wonder whether the company is still viable and relevant today. Is the stock, which trades below book value, even worth a look?
Based on its current valuation and the steps the company has taken to adapt, it's worth a serious look.
The times they are a changing'… and Xerox changes with them...
Ironically, Bob Dylan penned the referenced anthem around the time when Xerox's revenue was knocking on half a billion dollars, which was serious bank for 1963. And while it could've been easy for the firm to do very little and go the way of peers such as Polaroid and, presently, Eastman Kodak (NYSE: EK), it hasn't. [My colleague David Sterman thinks Eastman Kodak is headed for big trouble. Read his take here.] Remember, Xerox developed what became the famous Apple (Nasdaq: AAPL) operating system and, although the company viewed it originally as a failure (it sold it to Steve Jobs like you'd sell a broken lawn mower to a hoarder), it's still testament to the company's spirit of innovation.
Xerox still manufactures copiers and printing systems. But, like fellow tech giant IBM, it realized long ago the REAL money was in services, which now represents half of the company's total revenue, mix bringing in more than $10 billion last year alone. Total revenue for the company clocked in at $21.63 billion for 2010, a 42.5% jump from 2009's $15.17 billion. This year, estimatesfor $22.62 billion in revenue, not quite as dramatic a jump as the prior year, but going in the right direction, considering all the recession-predicting going on from the television punditry brigade.
While the revenue number is a bit underwhelming, earnings per share (EPS) growth is much more impressive. Third-quarter 2011 EPS came in at $0.26, which was an 18% bump from 2010's third-quarter report of $0.22 a share. Xerox's EPS forecast for the year is $1.10, which would be a stellar 155% jump from 2010's $0.43 per share.
These are great numbers, but the stock's valuation is even more compelling. Shares trade at 0.86 times book value and less than 0.5 times sales. So with the tailwinds of strong earnings growth and a strong brand name, why so cheap? There are a couple of reasons, some real, some not.
Last year, Xerox purchased Affiliated Computer Services for cash, stock and the assumption of debt. While this was a great acquisition for the company's service business (prior to that, Xerox was capable of addressing a $130 billion market. Now, this number sits at nearly a half a trillion), mergers rarely realize their implied synergy instantly. There are still some integration challenges, as is the case with any transaction. Secondly, the company is still having some problems adapting to the supply-chain disruption created by this year's massive Japanese earthquake. Lastly, and the most irrational reason buyers have avoided the stock, is fear of the effect a sluggish economy or even a double-dip recession could have on the company.
But, as always, the herd's medieval fear has created opportunity for smart investors.
When times are tough and companies are cutting everything they can, what's the first thing they do after firing the lower level of middle management? If you blurted out "outsource," you as the late, great Ed McMahon would say to Johnny Carson, "are correct sir!"
As I mentioned earlier, half of Xerox's business mix comes from services ranging from call-center functions to document and billing management. Best of all, the company's customer renewal rate in its service segment is 90%. That's an extremely predictable revenue stream. So, again, let the herd's stupidity work for you. This is a great business that's been priced very inefficiently.
Risks to Consider: While Xerox's revenue and earnings trends are encouraging, the company has a fair amount of debt, even prior to the ACS acquisition. This is primarily due to the company providing equipment financing to its customers. This is also an inherent risk. A slower economy means a challengin business environment, which will translate into a receivables portfolio that can become increasingly soured. Also, the macro picture for the business is worrisome as the world continues to shift toward digital documents, rather than hardcopies. Realizing this, the company is effectively evolving the business to the service segment organically and through acquisition.
Action to Take --> Last week, I was in a meeting with a couple of portfolio managers who referenced value investing as buying "cigar butt stocks," basically meaning stocks that have been thrown away and will eventually burn out completely, but have one or two puffs left in them. There's no denying Kodak was once a cigar butt. Xerox is a long way away from being thrown out on the sidewalk.
The stock trades at near $8.30 per share, with a forward price-to-earnings (P/E) ratio of about 7 and a dividend yield of 2%. Picking up the stock in this range is a great opportunity to buy a staid tech name, even though no one really considers it a tech name, at a bargain-basement price. A 12-month price target of $11 is reasonable based on potential P/E expansion of about 38% (only to 10 times earnings, which is still value stock territory). This means 2012 earnings, forecasted at $1.19 per share, only need to grow 8% year-over-year. Capital appreciation, plus the dividend, would put the total return at 30%.