Xerox (XRX -0.22%) initially seems like a cheap dividend stock. It’s a Fortune 500 company which provides print and digital document products and services across 160 countries, its stock trades at just eleven times forward earnings, and it pays a high forward dividend yield of 4.3%.
Xerox hasn’t raised its dividend since 2017, but it didn’t suspend its payments during the pandemic and spent just 53% of its free cash flow on that payout over the past 12 months. Its low valuation also might make it appealing as the market rotates from growth to value stocks. Those points are all valid, but I believe Xerox is actually a high-yield trap for five reasons.
Image source: Xerox.
1. Anemic gains over the past decade
Xerox’s stock has trailed the S&P 500, in terms of price growth and total returns (which include reinvested dividends), over the past ten years.
Source: YCharts
We shouldn’t judge a stock based on its past performance alone, but Xerox’s anemic returns indicate there’s something wrong with the company.
2. Declining free cash flow
Xerox’s trailing 12-month free cash flow, which feeds its dividends and buybacks, has also been declining over the past decade.
Source: YCharts
Those declines would have been even steeper if it hadn’t sold its 25% stake in its joint venture with Fujifilm (FUJIY 0.68%) for $2.3 billion in 2019.
Xerox expects to generate “at least” $500 million in free cash flow in fiscal 2021, up from $474 million in 2020, but it’s benefiting from an easy comparison to the pandemic last year.
3. Weak core businesses
Xerox splits its business into two main segments: equipment sales, which mainly come from its printers and copiers; and post-sale revenue, which includes its installation, maintenance, financing, and add-on service fees.
It generated 78% of its revenue from the post-sale business last year, and the rest from its equipment sales. Here’s how those two businesses fared over the past two years and the first quarter of 2021.
|
Revenue Growth (YOY) |
FY 2019 |
FY 2020 |
Q1 2021 |
|---|---|---|---|
|
Equipment |
(5.3%) |
(24.2%) |
17.2% |
|
Post-Sale |
(6.4%) |
(22.1%) |
(13.4%) |
|
Total |
(6.2%) |
(22.5%) |
(8.1%) |
Source: Xerox. YOY = Year-over-year.
Xerox faces two secular challenges. First, copiers and printers have long upgrade cycles, and the rise of paperless offices is throttling demand for new equipment. Second, Xerox sells its copying and printing supplies at higher margins than its hardware, but some of its customers are buying cheaper generic supplies from online retailers.
Xerox is trying to counter those headwinds by selling more high-end devices and subscription plans for its supplies and services. Unfortunately, its rival HP (HPQ -0.45%) is also adopting similar strategies.
4. Treading water by cutting costs
Those challenges have consistently squeezed its gross margins.
|
Gross Margin |
FY 2019 |
FY 2020 |
Q1 2021 |
|---|---|---|---|
|
Equipment |
32.6% |
27.4% |
27.9% |
|
Post-Sale |
42.5% |
40.3% |
38.0% |
|
Total |
40.3% |
37.4% |
35.7% |
Source: Xerox. YOY = Year-over-year.
In the second half of 2018, Xerox launched an initiative called “Project Own It” to cut costs by $1.5 billion over the following three years -- but those efforts didn’t significantly boost its operating margins.
Xerox’s adjusted earnings, which rose in 2019 after the Fujifilm deal, also plummeted in 2020 before rebounding slightly (with some support from buybacks) in the first quarter of 2021.
|
Metric |
FY 2019 |
FY 2020 |
Q1 2021 |
|---|---|---|---|
|
Adjusted Operating Margin |
13.1% |
6.6% |
5.2% |
|
EPS Growth (YOY) |
23.3% |
(60.3%) |
4.8% |
Source: Xerox. YOY = Year-over-year.
5. It needs to make bold moves to grow again
Xerox is stuck in the same rut as many aging tech companies: its revenue growth is stagnant and it’s relying too heavily on cost-cutting measures and buybacks to boost its earnings per share.
Xerox needs to make some bold moves to start growing again. Activist investor Carl Icahn previously tried to force Xerox to merge with HP, which would have generated synergies as a much larger printing company, but Xerox abandoned its $35 billion hostile bid a year ago.
For now, it’s unclear if Xerox will pursue new acquisitions to boost its revenues or spin off more businesses, as it previously did with its business services unit Conduent (CNDT -4.22%) and the Fujifilm joint venture, to generate more cash for buybacks and dividends.
Stick with other dividend stocks
All these challenges could make Xerox a disappointing dividend stock. It’s not headed off a cliff yet, but it will continue to tread water for the foreseeable future. Investors should stick with more promising dividend stocks which offer a better balance of growth and income.
