Recognizing the cyclical trend away from its core business of document technology, XRX bought Affiliated Computer Services (ACS) for $6.4 billion in 2009 to propel itself into the business process and IT outsourcing businesses (known as the services business segment). The company has been successful so far, in the last three years that business has grown from 23% of total revenue to 51% in 2012. In the first quarter of 2013, services represented 55% of sales.
Services backlog grew 64% in the most recent quarter and importantly that growth was driven by smaller deals which take less time to ramp up to profitability (vs. mega-deals). This, along with 5% growth in the pipeline bodes well for sales growth in future quarters.
No doubt, XRX's document technology business will remain under pressure in coming quarters. Management spent $100 million at the end of last year on restructuring initiatives that will mostly benefit this segment, driving significant cost savings for the overall company ($150-$160 million expected in 2013). In addition, the launch of ConnectKey (a new mid-tier printing equipment system) in the first quarter was later than expected, hurting the quarter. However, this should help to boost second quarter results.
Total company margins are set to expand beyond the 10% psychological threshold this year due to the restructuring, price discipline, ramping of services deals, the recent launch of ConnectKey, and an improving macro environment.
New CFO Kathryn Mikells started in early May and is also viewed as a positive for the company as she was poached from ADT Corp (ADT). In her prior position she played a significant role in transitioning ADT into an independent company after its spin from Tyco International (TYC). Just what XRX needs as it continues to build out the services business.
XRX's 2.4% dividend yield and commitment to buyback at least $400 million worth of shares this year show management's commitment to returning capital to shareholders. The dividend was increased in April by 35%. Of note, XRX's leverage at 2.5x debt / EBITDA is within the range where management feels comfortable, leaving open the opportunity to limit additional debt paydowns to the $400 million planned this quarter and use the remaining cash flow (driven by the document technology segment) for additional buybacks.
XRX certainly has a number of catalysts that have supported the recent momentum in the stock. At a P/E of 8.6x 2014 estimates, the stock is trading at a slight premium to its five-year average of 8.1x, which could make multiple expansion tough going forward. I would not be a buyer of the stock at current levels, but I would consider buying if there is a pullback ahead of the second quarter print in July.
Mark: XRX is about to threaten $10 a share for the first time in about two years. Its incredible the up and downs of this company. As the stock has rallied toward $10, the IV has actually crept up with the stock price. When we have a stock that we think is going higher, and the IV is near highs we typically look to sell puts instead of buying calls.
Earnings are on July 19, right before expiration. While I am sure IV might creep, I think it makes more sense to sell the 10 puts into a creep higher and then hold the 9 puts underneath. Trade: Sell to open 1 July 10 put at $0.62, buy to open 1 July 9 put for $0.13.
Lindsey can be followed on Twitter at twitter.com/lindseycbell
Mark can be followed on Twitter at twitter.com/OptionPit
OptionsProfits can be followed on Twitter at twitter.com/OptionsProfits
Check Out Our Best Services for Investors
- $2.5+ million portfolio
- Large-cap and dividend focus
- Intraday trade alerts from Cramer
Access the tool that DOMINATES the Russell 2000 and the S&P 500.
- Buy, hold, or sell recommendations for over 4,300 stocks
- Unlimited research reports on your favorite stocks
- A custom stock screener
- Model portfolio
- Stocks trading below $10
- Intraday trade alerts
More than 30 investing pros with skin in the game give you actionable insight and investment ideas.