(XRX) Xerox Stays at Neutral

We reiterate our Neutral recommendation on Xerox Corporation (XRX), which is a leader in the development, manufacture, marketing, servicing and financing of document equipment across the world. Headquartered in Norwalk, Connecticut, Xerox has its presence in more than 160 countries.

The company reported a profit of $281 million or $0.19 per share in the first quarter of 2011, including $53 million or $0.04 per share of charges on amortization of intangible assets. The profit reflects significant improvement compared with the year-ago loss of $42 million or $0.04 per share.

On excluding the charges, adjusted profit of Xerox amounted to $334 million or $0.23 per share in the quarter, barely exceeding the Zacks Consensus Estimate by a penny.

Revenues climbed 16% to $5.47 billion in the quarter, which was slightly lower than the Zacks Consensus Estimate of $5.50 billion. The rise in revenues was attributable to a 40% year-over-year growth in the Services segment.

Gross margin declined to 33.0% from 36.1% in the prior year due to the unfavorable impact of currency exchange rates and mix impact from the acceleration of growth in BPO and ITO revenues. However, operating margin rose to 9.1% from 8.5% due to higher revenues.

However, following the earnings release, estimates for Xerox have shown downward trends, particularly for the upcoming two quarters. The second quarter earnings estimate went down to 24 cents in the past 7 days from 26 cents in the past 30 days. The third quarter revenue estimate dropped by one penny only in the past 7 days to 25 cents.

The main reason behind the sagging confidence in the company’s near-future performance may be the recent mishap in Japan. Xerox imports certain essential components and materials from third party Japan suppliers.

Although the company has started evaluating alternative sources for these products, yet it seems difficult to fully avoid the impact of the Japan incident in the upcoming quarters. Thus, a supply constraint can increase supply chain costs. Reduced demand for products in the emerging markets of the Middle East is also likely to emerge, in turn impacting the company’s profit.

Another crucial factor is the availability of a large number of substitutes because of strong peer presence, although there are slim chances of new entrants. Companies like Canon Inc. (CAJ), Hewlett-Packard Company (HPQ), Lexmark International Inc. (LXK) and Toshiba Corp. aToshivbre growing faster to strengthen their global position in almost the same way as Xerox.

However, Xerox is making continuous efforts to improve its business through successful acquisitions. Recently, Xerox acquired WaterWare Internet Services and also purchased the U.K.-based Concept Group and Unamic/HCN B.V.

Moreover, Xerox plans to expand its business globally with its well-knit distribution network. The acquisitions of Premier Office Equipment Inc., ComDoc Inc., United Business Solutions, and Florida Imaging & Network Systems in the U.S. reflect the fact.

Xerox anticipates GAAP and adjusted EPS of $0.18–$0.21 per share and $0.23–$0.26, respectively, for the second quarter of 2011. For full year 2011, the company expects GAAP earnings between $0.89 and $0.94 per share and adjusted EPS in the range of $1.05 per share to $1.10. It also expects $1 billion to $1.2 billion in available cash for the year.

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