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Morningstar | Xerox's First-Quarter Revenue Continues Decline, While Cost-Cutting Boosts EPS; Maintaining $30 FVE

Xerox reported first-quarter results with significant revenue declines countered by improving profitability. The mixed earnings are in line with our thesis that the company’s seemingly ambitious cost-cutting initiatives are obtainable, but flat or growing revenue is not in the queue for Xerox over the next five years--counter to the company’s outlook. As a result of cost-cutting initiatives significantly hitting the bottom line, Xerox improved its EPS outlook for 2019. Accounting for the improved profitability expectations, our $30 fair value estimate for no-moat Xerox remains unchanged. With the stock approaching our fair value estimate, we recommend waiting for a wider margin of safety before investing in Xerox.

Xerox reported revenue of $2.2 billion for the first quarter, a decrease of 7% year over year in constant currency. While Xerox noted it had relative stability in page volume figures over the quarter, revenue declines were higher than our projected decline of 5% for the year. Xerox’s hit to revenue stemmed largely from declines in midrange equipment--down by 7.2% at constant currency. Additionally, post-sale revenue was down 6.8% at constant currency after unbundled supplies brought in lower revenue in developing markets. In our view, this dependence on unbundled sources of revenue will increase as Xerox’s eroding equipment market share will lead to a declining mix of bundled revenue. Post-sale revenue was also affected by services sales that experienced frictions as accounts switched to Xerox Business Services (XBS) from Managed Document Services (MDS).

Despite disappointing revenue, Xerox’s cost-cutting initiatives under Project Own It led to expanding adjusted operating margins of 11.3%, up 140 basis points from the prior period last year. Real estate efficiencies particularly helped boost profitability, as the company consolidated 83% of its offices targeted for consolidation under Project Own It. As a result, Xerox reported earnings per share of $0.91 in the first quarter, up from $0.23 in the prior-year period and increased its guidance for 2019 adjusted EPS to $3.80-$3.95 from $3.70-$3.80.

The creation of a parent company is still in the works for Xerox, as shareholders will vote on the reorganization on May 21. However, Xerox noted that the divestiture of its financing division may not occur, as it has yet to find a buyer. Our model does not include effects of such a divestiture, and therefore, the update does not affect our fair value estimate--though we think selling off the financing division would work in the company’s favor to reduce its debt burden.