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Morningstar | Xerox Running Out of Ink but Not Paper With Fading Revenue and EPS Growth; Maintain $27.50 FVE

Xerox reported fourth-quarter earnings half in black and white, half in color. While revenue declined (falling slightly less than our expectations), adjusted earnings per share grew with the help of Xerox’s operational efficiency program, Project Own It. The results proved that the company’s cost-cutting was able to negate the effect of revenue declines, which management expects to continue in fiscal 2019. However, we think this effect isn’t sustainable, which is pertinent because we think revenue declines will be a mainstay for Xerox in the long term--with little chance of a revenue cartridge refill. We believe demand for printing equipment and, consequently, Xerox's services is undergoing permanent decline. We therefore are maintaining our fair value estimate of $27.50 per share for this no-moat name, which places the stock in 3-star territory with high uncertainty. Nonetheless, we will be keeping our eye on specific revenue forecast details at Xerox’s investor day Feb. 5.

Xerox reported revenue of $2.53 billion for the fourth quarter, a decrease of 6.1% year over year in constant currency, and $9.83 billion for the full year, a decrease of 4.9% year over year in constant currency. Xerox’s other subsegment reported the worst declines, driven by a weakening original-equipment manufacturer business. While future revenue growth looks bleak, we expect workplace solutions to offer some buffer. Over the quarter, workplace’s ConnectKey products grasped more A3 equipment revenue market share. However, A4 market share would be a better catch, given its ability to capture higher service and supply costs. As for high-end equipment, Iridesse can also serve as a buffer on revenue declines, given its current positive adoption and ability to gain more share. All in all, we are eager to learn more details on Xerox’s revenue growth strategy during the upcoming investor day.

Product mix had little contribution to margins. Xerox reported adjusted earnings per share of $1.14 in the fourth quarter, increasing $0.11 year over year, and $3.46 for the full year, increasing $0.01 year over year. The increase was primarily led by Project Own It’s reductions in selling, administrative, and general expenses along with reduced accrual of performance incentive compensation. We expect the program will tackle more areas like IT infrastructure, real estate, and supply chain in the future. As a result, the program is expected to bring this year’s adjusted operating margin up to 12.6%-13.1% while Xerox expects revenue to decline at 5% in constant currency with adjusted EPS rising significantly to $3.70-$3.80.