Currently the stock is overvalued if earnings growth is only 3% going forward. Analysts expect earnings to grow at closer to 6% annually, so if I assume that rate for the next 10 years and 3% after that the fair value range grows to $5.88 – $11.15.
The best case scenario is that Xerox Corporation (NYSE:XRX) is fairly valued today, and depending on earnings growth the stock could very well be significantly overvalued. The massive level of debt is the real killer here.
Cheaper than the competition
Getting into the business outsourcing business has put Xerox in competition with companies like International Business Machines Corp. (NYSE:IBM) and Accenture Plc (NYSE:ACN). IBM has had its own share of troubles recently. Revenue declined in 2012 and again in the first quarter of 2013, leading the company to announce in April that it would begin laying off some employees. These layoffs started in June and are expected to reduce the headcount by between six and eight thousand. In addition CEO Virgina Rometty delivered a company-wide reprimand to employees in the form of a five-minute video after poor first quarter earnings.
International Business Machines Corp. (NYSE:IBM) also has significant debt and pension obligations, although relative to its market capitalization this debt level is lower than that of Xerox. IBM trades at an adjusted P/OE of about 15.4, higher than Xerox’s 13. Of course, International Business Machines Corp. (NYSE:IBM) doesn’t have a shrinking legacy business that makes up half of its revenue weighing it down, so this higher multiple is likely justified.
Accenture Plc (NYSE:ACN) saw strong revenue and earnings growth in 2012. Revenue grew by 8.9% while net income increased by 12.9%. The first quarter of 2013 continued this growth trend, and Accenture doesn’t appear to be slowing down. Accenture has no debt and less than $1 billion in pension obligations, leaving it a significant net cash position. Accenture Plc (NYSE:ACN) trades at an adjusted P/OE ratio of 16.5, higher than both IBM and Xerox. But the lack of debt and higher growth likely justify this premium.
The bottom line
Xerox Corporation (NYSE:XRX) is not a bargain like many people believe. The stock is at best fairly valued, and given that half of its revenue is from a declining business it’s difficult to expect anything but very slow earnings growth going forward. The debt levels are extremely high, although interest payments have been reduced substantially over the last few years. When the stock was trading near $6 per share at the end of last year it was much more appealing, but close to $10 per share it’s just not all that attractive.
The article This Stock Is No Bargain originally appeared on Fool.com and is written by Timothy Green.
Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Accenture. The Motley Fool owns shares of International Business Machines. Timothy is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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