Xerox: A High Dividend Yield on a Rebooted Business Model

When key value metrics — revenue, earnings, dividends — trend down, why should we expect the ultimate value metric, price, to trend up?
The question is easy enough to answer. For one, trends are never ordained to last in perpetuity. Companies have, and do, change course. In addition, trends tell you everything about the past, but they alone don’t divine the future.
A lot of things trended lower for Xerox Corp. (NYSE: XRX) in 2016: annual revenue posted at $10.8 billion for the year; in 2015, it posted at $11.5 billion. EPS came in at $0.58 in 2016; it came in at $0.77 in 2015.
As for the ultimate value metric, price, Xerox shares are down 16% over the past year. The trend analysis suggests we should look elsewhere.
True enough, but when you have a couple decades of investing experience on your résumé, you develop instincts that are worth heeding. My instincts told me to dig a little deeper into Xerox. I believe I’ve unearthed a legitimate value investment.
When you think of Xerox, you likely think of photocopying. The word “Xerox” is one of the more famous brand names that has been co-opted for use as an everyday verb.  (“Can you Xerox this document for me?”)
The public incorporating your brand name into the business lexicon can be a blessing or it can be a curse. It certainly ups brand awareness, which is a blessing if the brand is associated with growing a product or function. (For example, the iPhone is often used in place of smartphone.)
But if the business behind the trade name is perceived as fading, it can be a curse. Such is the case with Xerox: You think Xerox, you think photocopy. And if you’re an investor, you think, why would I invest in a photocopy company?
I have no interest in investing in a pure photocopy company, but Xerox is much more than a photocopying company. Xerox is really a document-management, technology, and business-services company.
In January 2016, Xerox announced it would separate its document technology and business process outsourcing businesses. This followed the November 2015 announcement that Carl Icahn and Icahn Capital had accumulated a 7.1% position in Xerox. (Icahn subsequently increased his stake to 9.8%.) The separation was completed at the end of 2016. Xerox’s spin-off will trade under the Conduent (NYSE: CNDT) name.
The Conduent spin will shrink Xerox. Annual revenue will fall to $10 billion, roughly $7 billion less than it would have been had it retained the Conduent business. The focus is document management going forward.
So, what does that mean to focus on document management?
It means that multi-function printers, copiers, digital printing presses, and light production printers will lead the charge. This hardware and their related services account for roughly 57% of revenue.
Going forward, Xerox plans to augment these businesses by acquiring new printing technologies. Xerox plans to enter the $65-billion commercial offset printing and packaging space this year. It has already budgeted $100 million to do so. These new printing technologies will take Xerox beyond paper to packaging, plastics, and electronics.
That said, the investment thesis centers on cash flow and value. Management expects cash flow from continuing operations to range between $700 and $900 million and free cash flow is expected to range between $525 and $725 million.
In the analysts’ meeting in January, management offered EPS guidance for 2017. EPS is expected to post between $0.80 and $0.88. Revenue should post at around $10 billion.
At Xerox’s current share price, it’s cheap if EPS expectations are achieved. With Xerox  shares trading at just over $7.30, the forward P/E multiple is only 8.7. This is a significant discount to the peer average multiple of 16.
And then there’s the dividend. For 2017, Xerox will pay a $0.25-per-share annual dividend. This produces a 3.4% yield, a respectable yield when you consider that the large-cap IT sector averages a 2.5% yield. Xerox’s printing peers average a 2.8% dividend yield.
I see improved financial performance for Xerox in 2017. Of course, I’m not the only value investor predicting improved financial performance. Let’s not forget another value investor (Carl Icahn) owns nearly 10% of Xerox shares.

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