Xerox - A Bet on Economic Improvement
Location: InvestWhatWorks CAPS Blog
When people think of Xerox, they probably think of copiers, printers and other business equipment. But in recent years, Xerox has been positioning itself as a business services and information-technology outsourcing company. While Xerox still often gets compared to other hardware companies, it is now much more similar to the business services companies.
There are many reasons why I like Xerox, but I’ll stick to four main reasons. One is changing revenues streams. Two is a play on economic improvement. Third is as play on interest rates. And the final is the company’s ability to safely increase its dividend.
Though Xerox is thought of as a hardware company, Xerox’s services division now makes up the majority of the company’s revenue. Services account for 49% of Xerox’s revenue, with technology making up 45% (the remaining 6% comprised of ‘other’ revenue streams).
This is in comparison to a little more than a year ago when technology made up 53% of Xerox’s revenue, with services only accounting for 39%.
Xerox’s business services are mix between a human resource outsourcing company (like an Automatic Data Processing (ADP) or Paychex) and an IT-outsourcing company (like IBM). The services under the Xerox umbrella include human resources, payroll, finance and accounting, customer care, IT-consulting, cloud computing services, data-management and document outsourcing (just to name a few).
Xerox could be a long-term play similar to IBM in the past. IBM slowly changed itself from a low-margin hardware business to a much higher-margin software and services business. Xerox similarly, as shown by their revenue streams, is de-emphasizing their focus on hardware in favor of higher-margin IT-outsourcing and business services.
This next point is very obvious, so I’ll just keep it short: Bring a business services and business hardware/equipment company, Xerox will benefit from an improvement in the economy and business environment. Fairly straightforward reasoning.
Xerox is also a play on rising interest rates. Similar to Paychex and ADP, Xerox’s payroll division earns interest on money they hold for their clients (money given to Xerox and held until later distributed their client’s employees). With interest rates low, these companies do not make as much money on their client’s held funds. Low interest rates are nothing new and they will remain with us for a while. But when interest rates do start to rise in the coming years, Xerox will benefit.
Xerox is not a pure play on interest rates rising in the future. Unlike ADP or Paychex, Xerox has more diverse offerings (compared to ADP and Paychex, whose businesses services are primarily payroll-related.) Xerox’s payroll services is only one of many of Xerox’s services offerings. Xerox is not dependent on interest rates. When interest rates to rise though, Xerox’s earnings from its payroll division stand to benefit greatly.
Xerox has a good dividend yield with a lot of room to grow it in the future. Xerox could double its annual dividend from 17-cents to 34-cents and the company would still have a dividend payout ratio of less than 50%. Currently, Xerox’s payout ratio is 22.8%. In comparison, ADP has a dividend payout ratio of 55.5% and Paychex has a payout ratio of 84.3%.
Reinvest that dividend back into Xerox. When we start to see substantial improvements in the economy and in interest rates, you will be in a great position to take advantage of those improvements with Xerox.