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Monday, October 23, 2006

Xerox Gives, Takes a Penny (XRX)(HPQ)(AAPL)(CAJ)

By William Trent, CFA of Stock Market Beat

In the latest sign that corporate spending is mediocre, Xerox Corp. (XRX) posted total sales growth of 2% year/year, half of which was due to currency fluctuations. Post-sale revenues (ink, toner, paper and services) were up 3% but equipment sales declined 1% (2% on a constant currency basis) as competitors like Hewlett Packard (HPQ) and Canon kept up the heat. As we noted in the past, if Xerox doesn’t sell equipment today, how can they expect to generate post-sale revenue tomorrow?

The company beat earnings estimates (after adjusting for tax benefits and restructuring charges) by a penny, but appears to have taken back the penny when it comes to next quarter’s guidance.

According to Yahoo! Finance:
Looking ahead, the company expects fourth quarter profit in the range of 34 cents to 37 cents a share, excluding restructuring charges. Analysts were expecting a profit of 37 cents.
“We expect our fourth-quarter performance will keep us on track to deliver our full-year earnings expectations,” Xerox chief executive Anne Mulcahy said in a statement.

Given how frequently Xerox records restructuring expenses, we don’t think it is appropriate to treat them as one-time events, but that is a story for another day. The restructuring charges reduced EPS by $0.14.

Also worrisome was the company’s working capital management. Year-to-date inventories are up more than 16% and receivables nearly 10%, though sales have grown just 1% from the first nine months of 2005. Expense management is coming not just from overhead but also from research and development, which could lead to further trouble down the road if the company finds itself out-innovated. However, we don’t look too harshly on the cuts in Xerox’ case because the company has a reputation for creating whiz-bang products that never make it to market. A more focused R&D effort could actually yield more with less, as Apple (AAPL) has shown.

The author may hold a position in the securities discussed. A current list of the author's holdings is available here.

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