Xerox Shares Are Reacting To What Matters: Operating Margin And Free Cash Flow

While the bottom line results were ahead of expectations, revenues came in below estimates. The company reaffirmed its full-year revenue guidance and narrowed its earnings per share guidance.

Reacting to the results, the stock rose 5.8 percent on Tuesday.

Loop Capital Markets in a note released on Wednesday that the stock reaction was in response to what matters, namely operating margin and free cash flow.

Xerox' adjusted operating margin rose 0.4 points year over year to 13.3 percent and free cash flow at $328 million, up from $177 million last year.

The company said it expects to generate free cash flow from continuing operations of $525 million to $725 million.

"Despite slightly softer revs, this is an OM / EPS / FCF story, and with solid EPS & FCF were encouraged by the results," the firm said.

Efficient Cost Saver

Analyst Ananda Baruah said he thinks Xerox has ample EPS powder to achieve his 2019 earnings per share estimate of $4, thanks to initially identifiable cost saves from the split. The analyst clarified that the company is good at cost reduction, targeting incremental cost savings of $500 million from 2016–2018 above its typical cost savings target of $1 billion.

Accordingly, the analyst sees 18–20-cent EPS accretion, even if 50 percent of the incremental cost savings is taken to the bottom line. Citing the positive impact of increased focus resulting from the split in companies such as HP Inc HPQ, the analyst said Xerox can benefit from the same (see Baruah's track record here).

Loop Capital expects free cash flow in the $900 million to $1.1 billion range, with the cash usage expected to be in deleveraging, maintaining investment grade, targeted investments, with focused M&A and capital return.

The firm also noted that the company is now targeting incremental revenue growth through:

• Strengthening the connected office portfolio including share gains in the A4 market.
• Increasing participation in small and medium business and the mid-market through channel partners.
• Share gains in graphic communications, including Industrial printing, and high-end products.
• Expanding leadership in managed print services, with enterprise and SMB.

Concluding, Loop Capital said, "We believe a more focused XRX post-splitting from its services business in December 2016 will afford even greater efficiencies for a company that has a solid history of strong cash flow and cost savings acumen in a secularly declining print market."

As such, Loop Capital reiterated its Buy rating on Xerox and raised its price target from $36 to $38.