What a brutal six months it’s been for Xerox. The stock has dropped 40.7% and now trades at $3.93, rattling many shareholders. This was partly driven by its softer quarterly results and may have investors wondering how to approach the situation.
Is now the time to buy Xerox, or should you be careful about including it in your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why Do We Think Xerox Will Underperform?
Even with the cheaper entry price, we're swiping left on Xerox for now. Here are three reasons there are better opportunities than XRX and a stock we'd rather own.
1. Revenue Spiraling Downwards
A company’s long-term performance is an indicator of its overall quality. Any business can experience short-term success, but top-performing ones enjoy sustained growth for years. Xerox struggled to consistently generate demand over the last five years as its sales dropped at a 4.9% annual rate. This was below our standards and is a sign of poor business quality.
2. New Investments Fail to Bear Fruit as ROIC Declines
A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, Xerox’s ROIC has decreased significantly over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
3. High Debt Levels Increase Risk
Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.
Xerox’s $3.94 billion of debt exceeds the $449 million of cash on its balance sheet. Furthermore, its 8× net-debt-to-EBITDA ratio (based on its EBITDA of $465 million over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Xerox could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
We hope Xerox can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.
Final Judgment
We cheer for all companies making their customers lives easier, but in the case of Xerox, we’ll be cheering from the sidelines. After the recent drawdown, the stock trades at 2.5× forward P/E (or $3.93 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are better stocks to buy right now. We’d recommend looking at an all-weather company that owns household favorite Taco Bell.
Stocks We Would Buy Instead of Xerox
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