Wall Street Analysts are Wrong About This Tech Stock, Here's Why

Shares of Xerox (XRX) have significantly trailed the broader markets in the past two decades. For instance, the S&P 500 Index ($SPX) has surged 340% since September 2003. After adjusting for dividends, the index has returned close to 550%.

In this period, Xerox stock is down 2.5%, while it has returned a paltry 12% if we account for dividends. 

Given this long-term underperformance, it's no surprise to find that Wall Street is overwhelmingly bearish on XRX. However, the shares are showing some signs of strength lately. Over the last month, XRX is up more than 3%, while the S&P 500 is nearly unchanged over this period.

Let’s see what's behind the price action in XRX, and whether it might win over some of its skeptics with a continued rebound. 

Xerox Beats on Q2 Earnings

Valued at a market cap of $2.54 billion, Xerox is a workplace technology company that builds and integrates software and hardware for enterprises. It designs, develops, and sells document management systems and solutions in several markets. Xerox offers workplace solutions that include desktop monochrome and color printers as well as digital printing presses and light production devices. Additionally, it provides graphic communications and production services, network infrastructure, and managed IT solutions. 

One of the key reasons for the underperformance of XRX is the company's slowing sales growth and narrowing profit margins. Revenue has declined from $9 billion in 2019 to $7.16 billion in the last 12 months. Comparatively, adjusted earnings per share have fallen by 20% annually in the past five years. 

However, in the last year, Xerox has taken significant steps to strengthen its operating and financial discipline, leading to another quarter of profitable growth amid a challenging macro backdrop. 

While sales grew by 0.4% year over year to $1.75 billion, its adjusted earnings rose almost 50% to $0.44 per share in Q2 of 2023. Xerox improved gross margins to 34%, up from 31.9% in the year-ago period. Its cost optimization efforts enabled Xerox to end Q2 with an operating margin of 6.1%, an improvement of 410 basis points compared to the last year. 

Those higher margins allowed Xerox to report an operating cash flow of $95 million, an improvement of $180 million year over year. Its free cash flow also grew to $88 million, compared to a cash outflow of almost $100 million in the year-ago period. 

Xerox now forecasts an operating margin between 5.5% and 6% in 2023, while free cash flow is forecast at $600 million this year.

XRX as a Dividend Stock

Xerox has lowered its balance sheet debt by more than $600 million in 2023, which has reduced interest expenses significantly. However, the company still ended Q2 with a total debt of $3.32 billion, which is quite high.

Xerox needs to consistently generate cash flows that can be used to reinvest in capital projects, reduce debt, and increase dividend payouts. In recent months, Xerox has focused on implementing a flexible cost base and direct investments toward margin-accretive growth opportunities. 

It also aims to return at least 50% of free cash flow to shareholders via dividends. The company pays investors a quarterly dividend of $0.25 per share, indicating a yield of over 6%. Given the number of outstanding shares, its dividend payments totaled less than $40 million in Q2, indicating a payout ratio of less than 50%.

What Do Analysts Expect for XRX?

Analysts remain overwhelmingly cautious on XRX. Out of the three analysts covering XRX, one recommends “hold,” and two have a “strong sell” recommendation. The average target price for XRX is $15.33, which is a discount of more than 3% to the stock's current levels. 

Despite these bleak analyst ratings, Xerox stock has a lot going for it at current levels. Priced at 4.2x free cash flows and 10x forward earnings, XRX is very cheap. 

Notably, the stock has surged 19% in 2023 after adjusting for dividends, which is in line with the S&P 500's performance. It has also crushed consensus earnings estimates in each of the last three quarters. If Xerox distributes 50% of cash flows in dividends, investors can expect payouts to rise as well in the next 12 months.