There Are Better Options Than This Document Equipment Manufacturer

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Xerox ) has become synonymous with the copying industry, so much so that office workers will actually refer to a copier manufactured by another company as “the Xerox.”  However, with lower corporate spending and lower margins leading to flat revenue, I believe that this particular company is a bit too pricey, even at the single-digit P/E multiples that it trades for.

Profile

Xerox is one of the leaders in document equipment, such as printers, copiers, fax machines, and multifunction devices.  The company operates in over 160 countries, but most revenue (64%) comes from the U.S. 

45% of Xerox’s sales come from the Technology segment, which includes all of their machines sold to businesses and individuals.  The rest comes mainly from the Services segment, which involves business process outsourcing (BPO), document outsourcing, and information technology outsourcing. 

Most of Xerox’s recent growth can be attributed to its acquisition of Affiliated Computer Services (ACS) for $6.4 billion, and this deal tremendously increased the company’s service capabilities.  Before the merger, 80% of ACS’s income came from services which include equipment rentals, maintenance, supplies, and financing.

Challenges facing Xerox are mainly due to two things: decreased enterprise/government spending and dropping margins.  The latter is due to the intense competition and pricing pressure from other companies such as Canon ) and Hewlett-Packard ), both of which are several times larger and more financially flexible than Xerox.

Valuation

On the surface, Xerox looks relatively cheap, trading at just 7.1 times forward earnings.  However, given the debt load of the company, and the stagnant growth projections for the next few years, this may even be too much. 

Xerox’s revenues dropped 1% in 2012, and are projected to increase by 1.5% in 2013, however a slightly better operating margin is expected to produce earnings growth.  2013’s consensus earnings of $1.12 per share are expected to rise to $1.19 and $1.27 in 2014 and 2015, respectively, for earnings growth of 6.3% and 6.7%. 

This still sounds like pretty reasonable valuation, until you factor in the company’s $8.4 billion in long term debt. When you add this to Xerox’s market cap of $10.3 billion, the market is actually valuing Xerox at about $14.70 per share or 13.1 times forward earnings, which is a bit high considering the slow and uncertain growth. 

Alternatives

Hewlett-Packard is one of the leading makers of printing and copying equipment, as well as a variety of computers and peripherals.  I wouldn’t consider HP for a long-term investment until its new turnaround starts to produce tangible results.  CEO Meg Whitman recently said that the company will experience earnings growth next year, a statement that helped fuel the stock’s recent rally off its low of $11.35 just a few months ago.  If it were still in the low-to-mid teens, I would recommend taking a chance on HP, but at the current levels, I don’t think the potential reward quite justifies the risk.

Canon, which is based in Japan, has proven itself to be able to create shareholder value even in the face of changing industry conditions.  At first glance, Canon may appear expensive at over 16 times forward earnings.  However, of the major printing/copying equipment manufacturers, Canon is by far the most stable company, revenue and earnings-wise.  They also have over $8 billion in cash and virtually no long term debt, a huge positive for long-term investors.

Conclusion

As far as document equipment companies go, there are slim pickings as far as long-term investability goes.  However, if you insist on investing in this sector, a stable company with a diverse product line such as Canon seems to be the way to go.  Barring a pullback of 20% or so, Xerox is definitely a “stay away” as far as I’m concerned.

 


KWMatt82 owns shares of Hewlett-Packard Company. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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