Xerox Holdings: Earnings Growth Remains Fundamentally Challenged

seekingalpha10-31 10:26

I maintain a sell rating on Xerox Holdings due to fundamental business challenges and poor earnings growth prospects.XRX missed its FY24 guidance, with 3Q24 revenue declining 7.5% y/y and ...

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I remain sell-rated for XRX as I see the business as fundamentally challenged, leading to poor or negative earnings growth over the foreseeable future. Investment Thesis XRX continues to publish disappointing results, and just as I expected, it was not able to meet its original FY24 guidance. XRX 3Q24 revenue came in at $1.528 billion, representing a 7.5% y/y decline. On a constant currency [CC] basis, revenue has declined for the 5th straight quarter. Splitting by segments, equipment & supplies saw $588 million in sales (8.7% y/y decline); services, maintenance, and rentals saw $902 million in sales (6.2% y/y decline). The weak results did not just end at the revenue line; profitability declined across the board. Gross margin fell by 60 bps sequentially; adj. EBIT margin fell by 20 bps sequentially, and net margin fell by 20 bps sequentially. Comparing to consensus estimates, XRX missed across the board: adj EPS came in at $0.25 vs. $0.508; revenue came in below consensus estimate of $1.626 billion; gross margin came in below consensus estimate of 33.55%; and adj EBIT margin came in below consensus estimate of 6.93%. In light of such a weak performance, management cut its FY24 guidance again (validating my previous thesis that XRX cannot meet its prior FY24 guidance). For the second consecutive quarter, management cut FY24 guidance. Revenue growth is now expected to be down 10% from the prior range of 5% to 6% decline. The minimum adj EBIT margin was also reduced from 6.5% to 5%, and likewise, the minimum FCF is now lowered to $450 million from $550 million. Notably, management no longer expects to grow adj EBIT by $300 million above FY23 levels by FY26. Recapping from my previous post, I noted three points that were embedded into the prior FY24 revenue guidance: (1) Equipment revenue returns to positive y/y growth as XRX benefits from improving order trends; (2) easier growth comp base in 2H23; and (3) a refreshed A3 product lineup. Of these three points, I expected points (1) and (3) to be the main contributors (if, in any case, XRX were to meet its guidance). Regarding point (1), on top of the structural headwinds (more remote work) that I noted previously, 3Q24 also shed light on severe execution issues, which led me to believe equipment revenue growth will remain weak for the foreseeable future. Specifically, because of XRX's reinvention plan, its go-to-market motion has been heavily disrupted, in that sales conversions trended below historical levels due to fewer sales reps (recap: XRX cut 15% headcount) and reduced repo with buyers (previously built relationships went away as sales teams got sized down). This further extended the sales cycle, which was already elongated due to the uncertain macro environment. As for point (3), XRX demonstrated similar execution issues that put doubts on any signification contribution. In the quarter, two print product launches were delayed as XRX struggled to flush through older products prior to the release of the new product. As such, while 4Q24 is going to enjoy an easier comp vs. 3Q24 (3Q23 revenue down 9.1%), I don't see points (1) and (3) being meaningful contributors to re-accelerate growth for the foreseeable future. Shifting attention to the reinvention plan, I acknowledge that management found some success - adj EBIT grew y/y despite revenue decline. To reiterate, the reinvention plan goal is to improve operational efficiency by simplifying the business geographical footprint and offerings and also implement cost savings measures (like the layoff they did earlier this year). So far, simplification of geographical footprint has made decent progress in that XRX has transitioned from a direct to an indirect operating model (lesser fixed cost involved) in Ecuador, Peru, Chile, Argentina, Hungary, and Bulgaria. XRX has also exited the manufacturing of certain non-core print equipment and its paper business in EMEA. Relating to timeline, management mentioned they remain on track to realize $200 million in total cost savings in 2024. Bloomberg All these seem good, but my stance is that this is not a sustainable earnings growth driver, as XRX can only cut so much cost. After the fats are being cut, the business still needs revenue growth to drive earnings growth. The reality is that XRX has missed consensus EPS estimates for the past four quarters, and management cut FY24 EBIT margin guidance - the latter reinforces my point that a deteriorating revenue base will continue to pressure earnings growth. Valuation The question is, how much lower can XRX valuation go from here? XRX valuation has improved from the previous ~5.3x forward PE to ~6.5x forward PE in September, which, I believe, was due to investors being optimistic that XRX can meet its FY24 guidance. With the 3Q24 results out and FY24 guidance cut, the stock immediately took a beating post earnings, driving valuation down to 5.6x forward PE. Despite some success with the reinvention plan, I believe the business fundamentals have not seen any major structural improvements vs. the last time I wrote about it. The structural headwinds remain the same (lesser demand for office printing equipment), and XRX is going to continue facing challenges from the changes made in its sales function. The acquisition of ITsavvy may help headline growth (inorganic growth contribution), but it does not change the fact that organic growth remains poor. As such, my view is that the stock will at best be range-bound, with the potential to re-rate downwards to <5x forward PE (near all-time low) if XRX reports another poor quarter. Risk The stock could go up if management decides to allocate a substantial portion of free cash flow into buying back shares (close to 50% FCF yield based on FY25e FCF estimates). Even though this is at the cost of future earnings growth, the short-term momentum generated from the buyback could drive market interests, leading to a share price surge. Conclusion  In conclusion, my rating for XRX is a sell rating as the business struggles with declining revenue. While the reinvention plan has shown some progress in cost reduction and operational efficiency, I don't think it is sufficient to offset the structural headwinds impacting the printing industry. Given the weak revenue outlook and potential for further margin compression, I maintain a sell rating on XRX.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2479779181"}