Dividend stocks are everywhere, but many just downright stink. In some cases, the business model is in serious jeopardy, or the dividend itself isn't sustainable. In others, the dividend is so low it's not even worth the paper your check is printed on. A solid dividend strikes the right balance of growth, value, and sustainability.
Today we're going to look at one dividend-paying company that you can put in your portfolio for the long term without too much concern. This isn't to say that these stocks don't share the same macro risks that other companies have, but they are a step above your common grade of dividend stock. Check out the previous selection.
This week, we'll turn our attention to a truly underappreciated name in the tech and health-care space, Xerox (XRX +0.00%), and I'll show you why this former dinosaur could be ready to roar again.
Switching gears isn't easy
As Xerox is finding out, its biggest challenge is in changing the perceptions of investors and other enterprises.
Source: Xerox
Historically, Xerox has been known as the developer of bulky copy machines and printing services. This isn't to say that Xerox doesn't still make copiers or handle printing and document solutions for big business, because it does. But with the digitization of nearly everything these days Xerox had to look beyond just the printing business and expand its horizons. That expansion has led to a number of peaks and troughs in Xerox's share price throughout the years.
Take its fourth-quarter results, for instance, which were announced in January. For the quarter, revenue dipped 3.4% to $5.57 billion while net income fell almost 9% to $306 million from $335 million in the year-ago quarter. Ongoing restructuring costs continued to hamper its bottom-line results with adjusted EPS of $0.29, matching already lowered expectations. As expected, its document technology business continued to struggle with sales down 6%, but its supposedly stronger service business only delivered flat revenue growth.
Xerox has also dealt with its fair share of PR flubs recently. A lot of the heat for Obamacare's botched rollout in October and November went to CGI Group (GIB +0.80%), the lead architect behind the federally run Obamacare website, Healthcare.gov. Since December, though, many of those glitches have been addressed, pushing CGI out of the limelight and leaving a handful of state-run exchanges, which struggled dangling in the spotlight. Xerox was one of those stragglers since it was the lead architect behind Nevada's woeful online marketplace. Although Nevada decided to renew Xerox's contract, it's clearly on a short leash to fix the exchange prior to the November 2014 open-enrollment period for 2015.
The Xerox advantage
Xerox's secret weapon that could win over Wall Street and pump up the company's profits throughout the remainder of the decade is its service segment. Specifically, Xerox is moving away from document services and attempting to boost IT-service revenue to roughly 65% of its total sales before the end of the decade.
While Xerox's ventures in Nevada have been a failure, the overall impact of Obamacare on the company should be quite positive.
Source: Xerox
For one, Xerox is California's processor of Medicaid claims, handling more than 90 million in just the first six months on the job. Considering that California was one of 26 states to take federal money to expand its Medicaid program, and it's also the state that brought in the greatest number of enrollees, it's quite likely that Xerox is only going to see an increase in the number of payments it's processing.
It doesn't stop there, either: Xerox is also an aggregator of funds on behalf of select states for the Medicaid expansion. In other words, it's the intermediary between the federal government and Medicaid expansion states, collecting the federal payouts and dispersing them to the states.
Furthermore, through its subsidiary Buck Consultants, which operates RightOpt, Xerox should be able to capitalize on the move by larger firms toward private health exchanges. By offering employees a subsidy and turning them loose to obtain their own health insurance on private exchanges employers are aiming to saving a small fortune, while Xerox's subsidiary is looking to add members en masse. By mid-November, RightOpt was servicing 400,000 participants, including Arby's Restaurant Group, Bob Evans Farms, Church & Dwight, Domino's Pizza, and, of course, its parent, Xerox.
Xerox has also delivered a number of IT-service wins outside of the health-care sector. Last year Xerox won a five-year, $100 million contract from the Texas Department of Transportation to establish tolling operations in Austin, Texas, to process more than 8 million monthly toll transactions and handle more than 750,000 accounts. Xerox has a number of other toll-servicing contracts throughout the United States.
Show me the money, Xerox!
In addition to the allure of breaking into the IT-service business and potentially seeing strong growth from this segment, Xerox has been something of a cash flow cow for shareholders in recent years. In order to boost shareholder value during its transition it's been tightly managing its expenses and making sure to return as much as it reasonably can to shareholders in the form of a dividend. The result has been a 47% increase to its quarterly payout since it began paying a dividend once again in the fourth quarter of 2007.
Source: Nasdaq.com, 2014 figures assume $0.0625 payout per quarter
As you can see above, Xerox has gone from paying out just $0.17 per year to its current payout of $0.25 for a yield of 2.3%. Based on Wall Street's projected EPS of $1.13 in fiscal 2014 its payout ratio of 22% might seem a bit light, but keep in mind Xerox is also working toward paying down $8 billion in existing debt, so it has to divert at least some of the roughly $2 billion in free cash flow it produces annually to debt extinguishment and its ongoing restructuring.
Overall, I believe Xerox's IT-service division has years of high-single digit growth potential and its dividend could very easily rise another 50% without much concern as to its sustainability. Income-seeking value investors would be wise to add Xerox -- which is valued at just nine times forward earnings and 1.1 times book value -- to their watchlist as I think it's a dividend stock you can trust.
