This Forgotten Market Leader Is Making All The Right Moves

StreetAuthority Network

Roughly a decade ago, technology futurists predicted we'd be living in a paperless world by now. It hasn't happened as fast as they predicted, but with each passing year, digital publishing -- from newspapers to utility bills to corporate invoices -- is tightening its grip.

The executives at Xerox (NYSE: XRX) saw the writing on the wall, realizing that demand for its printers, copiers and fax machines did not have a bright future. So in 2009, they made an audacious $6.4 billion bid for Affiliated Computer Services (ACS), a leading provider of business process management and outsourcing services. The move delivered instant returns.

Fast-forward to 2014, and those returns are still flowing in. Xerox is now one of the leading generators of "Total Yield," which is a key investment strategy you should be tracking.

Simply put, "Total Yield" stocks are companies that use the cash they generate to 1) pay steady dividends, 2) buy back large amounts of their own stock, and 3) pay down debt.

Why should investors care about these three strategies? When companies execute on all three fronts, it beats the S&P 500 -- as well as regular dividend investing -- hands down. (To learn more about this strategy, read our step-by-step guide.)

I'll explain how Xerox executes these three shareholder-friendly moves in a moment, but first it's important to understand the transformation Xerox has undergone in the last few years.

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A Booster Shot For The Income Statement
Back in 2009, Xerox had no choice but to be bold. Its revenue dropped 14% that year to the company's lowest levels since 2003. Adding ACS and its team of consultants reversed that trend, leading sales to spike 40% in 2010, to $21.6 billion.

Fully 80% of the company's revenue base is now recurring, one of the highest ratios of any company you'll find in the S&P 500. Equally important, ACS helped Xerox to maintain steady profit margins, which would have steadily eroded as demand for Xerox's office equipment slowly shrank.

The $6.4 billion acquisition had some drawbacks: Xerox's $3.8 billion cash balance at the end of 2009 dropped to just $1.2 billion a year later. And shares outstanding swelled from 880 million to 1.35 billion shares. Yet since then, the combined Xerox/ACS entity has been a cash machine: The company is likely to report that it produced around $1.9 billion in free cash flow in 2013 when results are reported Jan. 24. (In fact, Xerox generated roughly $1.6 billion in free cash flow in the prior three years as well.) That kind of cash flow has enabled the firm to deliver the three pillars of Total Yield: debt reduction, share buybacks and dividend payments.

By the end of 2009, Xerox's debt load had grown uncomfortably large: $9.9 billion in loans is a lot to worry about, especially for a company that still counts on a decent chunk of its income from legacy technologies. Since then, Xerox has been chipping away at that mountain: long-term debt slid below $9 billion in the spring of 2011, and now stands around $7.5 billion. 

Meanwhile, Xerox has maintained a $0.17-a-share annual dividend (which may soon get more attention now that debt is at more manageable levels, relative to cash flow). 

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Yet share buybacks are where this company is really accelerating its efforts. By the end of 2011, thanks to stock options grants and a few small stock-for-stock acquisitions, Xerox's share count had bloated to 1.44 billion shares. Since then, the company has allocated more than $1 billion toward buybacks, and you can already see the impact.

Xerox's falling share count

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Shares outstanding (millions)

In recent quarters, Xerox's pace of buybacks slowed, so in November 2013, the company announced that another $500 million would be added to an existing program. 

As noted, Xerox is unlikely to take debt down much further, and the company has articulated a new strategy for 2014. In addition to that buyback effort, the company will also spend around $300 million on its dividend (which should work out to be around $0.24 a share), and up to $500 million on acquisitions.

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In effect, this technology veteran has become a steady provider of Total Yield, first with vigorous debt reductions, then with a large share buyback, and now a three-pronged focus on dividend boosts, further buybacks and acquisitions. Had Xerox never acquired ACS back in 2009, the company might have found itself struggling for survival, as we've seen with Eastman Kodak and other office equipment/imaging leaders.

Risks to Consider: Xerox continues to face legacy declines in its core office equipment niche and will need those planned acquisitions to strengthen its more appealing IT consulting division.

Action to Take --> As noted earlier, Xerox will deliver year-end results this week. Don't look for blowout results, but keep a close on the company's financial statements. Free cash flow will likely be quite close to the $2 billion mark, which will lead management to discuss its 2014 Total Yield strategy in greater depth.

You can overlay the Total Yield analysis on other mature firms as well. A company might no longer delivering robust growth, but it can still take clear steps to reward investors through buybacks, dividends and debt reductions.

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