This High-Yield Dividend Stock Might Be in Trouble


Xerox (NYSE:XRX) seems like a cheap dividend stock on the surface. It’s a Fortune 500 company that provides print and digital document products and services across 160 countries, its stock trades at just 11 times forward earnings, and it pays a high forward dividend yield of 4.3%.

Xerox hasn’t raised its payout since 2017, but it continued paying dividends throughout the pandemic, and spent just 53% of its free cash flow on those payments over the past 12 months. Its low valuation could also make it more appealing as the market rotates from growth to value stocks. Those points are all valid — but I believe Xerox is still a high-yield trap, for five reasons.

Xerox's logo on an office building.

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 its reinvested dividends), over the past ten years.

XRX Chart

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 its business model.

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.

XRX Free Cash Flow Chart

Source: YCharts

Those declines would have been even steeper if it hadn’t sold its 25% stake in its joint venture with Fujifilm (OTC:FUJIY) for $2.3 billion in 2019.

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Xerox expects to generate “at least” $500 million in free cash flow in fiscal 2021, up from $474 million in 2020, but it will benefit 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 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%)

Data 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 curbing demand for new equipment. Second, Xerox sells its copying and printing supplies at higher margins than its hardware, but it faces fierce competition from generic supplies.

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 (NYSE:HPQ) is also adopting similar strategies.

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4. Treading water by cutting costs

Those challenges have consistently squeezed Xerox’s gross margins.

Gross Margin

FY 2019

FY 2020

Q1 2021

Equipment

32.6%

27.4%

27.9%

Post-Sale

42.5%

40.3%

38%

Total

40.3%

37.4%

35.7%

Data 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 tumbled 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%

Data 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 could have generated operating efficiencies and synergies as a much larger printing company, but Xerox abandoned its $35 billion hostile bid a year ago.

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It’s unclear if Xerox will pursue new acquisitions to boost its revenue, or spin off more businesses — as it previously did with its business services unit Conduent (NASDAQ:CNDT) 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 won’t slash its dividend anytime soon, but its stock will continue to tread water for the foreseeable future. Investors should stick with more promising dividend stocks that offer a better balance of growth and income in this fickle market.

 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.




View more information: https://www.fool.com/investing/2021/06/05/this-high-yield-dividend-stock-might-be-in-trouble/

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