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Introduction

In my earlier article we discussed which company is a winning bet among the stocks in the networking industry. We found out that the leading networking company, Cisco Systems (CSCO), is currently selling at attractive valuations. In addition, this company seems much more favorably positioned as compared with some of its competitors, such as Alcatel-Lucent (ALU) and Juniper (JNPR).

On the February 13, 2013, the company announced its second-quarter results with much pride. So let's all take a deep breath and take a look at whether Cisco's stock continues to stay a juicy stock for its investors.

Tracking Financials

At the release of the latest earnings announcement of Cisco for the period 2Q13, I drafted the valuation model for Cisco Systems and was convinced to hold the same stance on it as before but only with a firmer stance. Cisco delivered record earnings per share in Q2 2013 and record growth in revenues for previous eight quarters in a row. In a period of an year, Cisco's EPS grew at a rate of 47.5% further cementing my positive view.

(click to enlarge)

(click to enlarge)

The company has an attractive dividend policy for its investors that proves to be an attractive force for investors to bet on the networking giant. This adds to the fact that Cisco stock has been gradually hiking over time as investors are getting inclined toward it due to its consistent positive earnings and consistent high dividend Payout ratio. With the analyst estimated dividend yield of 2.7%, it is expected to reap a profit of 12.4% by next year, though I believe that returns will be higher than the analyst estimates.

Stock Performance

Cisco's aggressive price cuts in its products and dominant market position paved its way to gain market share from rivals Juniper and Alcatel-Lucent in an uncertain economic environment so far and could help it even further when the concerns subside.

Despite a challenging macroeconomic environment, the networking giant continued to perform better than rivals such as Juniper Networks, which is a good sign that its turnaround efforts are paying off at key routing and switching businesses. Cisco's Q2 FY 2013 results show that Net Sales grew 5 percent and operating income increased 2 percent over the same period last year. On other hand, Juniper Networks' revenue was up 2 percent in the last quarter compared with the same quarter last year.

In the year 2012, where Cisco's competitors' revenue growth has fallen to the pits of negativity, it has showed resistance to entering the negative growth territory. The growth has faded over years, but it is still a remarkable figure when compared with its competitors.

Revenue Growth

2010

2011

2012

Cisco

11%

8%

7%

Juniper Networks

23%

9%

-2%

Lucent

-1.3%

7.4%

-3.7%

Source: Company's Financials

Cisco revenues increased by 7 percent to USD 46.061 billion in 2012, compared with USD 43.22 billion in 2011. Within total revenues, product revenues increased by 6 percent and service revenues increased by 14 percent, each as compared with fiscal year 2011. With regard to its geographic segment performance, net revenues improved by 6 percent in the United States and Canadian segment, 6 percent in European Markets segment, 14 percent in Emerging Markets segment and 12 percent in its Asia Pacific Markets segment. Customer market product revenues performance in fiscal year 2012 was determined by increases in its commercial, service provider and enterprise markets.

Cisco's higher profit margin indicates its strength over its competitors that it manages to generate earnings in such challenging macroeconomic conditions. Cisco's profit margin increased by 2.5 percent to 17.5 percent in 2012, compared with 15 percent in 2011. A one-time tax benefit also helped Cisco to boost its earnings.

Net income Margin

2009

2010

2011

2012

Cisco

17.0%

19.4%

15.0%

17.5%

Juniper Networks

-3.5%

-2.1%

7.1%

-12.8%

Lucent

3.5%

15.1%

9.6%

4.3%

Source: Company's Financials

Fundamental Analysis & Forecast

I have performed a detailed analysis on the Cisco Systems to analyze its previous trend and forecast its financial stance in the coming years. I have observed that the cumulative average growth rate, in revenue, of Cisco was 5.7% for last five years as compared with 9.2% for last seven years, depicting that the growth rate of Cisco has decreased over the recent years. This fact is also evident in EBIT and is magnified when it falls down to Net Income and Earnings per Share (EPS).

The Free Cash Flow per Share has a cumulative average growth rate of 6.3% over last five years compared with cumulative average growth rate of 9% over seven years.

Growth Analysis

CAGR

5 Years

7 Years

Revenue

5.70%

9.20%

EBIT

3.40%

4.70%

Net Income

1.90%

4.90%

EPS

4.90%

8.00%

BV / Share

12.90%

15.10%

FCF / Share

6.30%

9.10%

In the light of the previous growths achieved by the company and expected stance it may have, I have assumed a growth rate of 6.3% for year 2013 and 6.12% for 2014. Over the period of two years the Revenue reached a level of USD 52 billion, Net Income was calculated at USD 9.1 billion and earnings rose to USD 1.632 per share.

Data in USD billions

Key Financials

2012 - A

2013 - E

2014 - E

Revenue

46.1

49

52

EBIT

10.3

14

14.5

Net Income

8.2

8.3

9.1

Capital

51.3

53

57

Total Assets

91.8

92.1

98.7

FCF

10.4

8.7

10.8

EPS

1.49

1.5

1.632

DPS

0.28

0.48

0.53

BV/Share

9.55

10.18

10.92

When I forecast the ratios, I came up with an EBIT margin of 28.57% in 2013 that dipped a bit in the next year to clock in at 27.88%. Net Income margin remained 18% in 2014, same as 2012 whereas the asset turnover rose to 53%. Over the coming years, return on equity has been sticking at 16%, which was quite consistent.

Ratios

2012 - A

2013 - E

2014 - E

EBIT Margin

22.34%

28.57%

27.88%

Net Income Margin

18%

17%

18%

Asset Turnover

50%

53%

53%

ROE

16%

16%

16%

At the end I looked at the forward looking multiples of Cisco as of today.

Forward Looking Multiples

2012 - A

2013 - E

2014 - E

P/S Multiple

2.4

2.2

2

EV/EBITDA Multiple

7.7

5.2

4.9

P/E Multiple

14.03

13.93

12.81

What Is a Fair Stock Value for Cisco Systems?

There are many ways to estimate the fair stock value of a company. For this purpose, we applied the discounted-earnings-plus-equity model developed by EFS Investment analysts to Cisco's case. The calculations based on this model allow us to suggest the following: At a price of about $21, CSCO stock is well undervalued. According to the discounted-earnings-plus-book-value model, the fair-value range for Cisco Systems spans between $27 and $38 per share. Hence, EFS' fair stock price valuation indicates that on March 1, 2013, undervalued Cisco's stock has at least 31% upside potential to reach its fair value.

Conclusion

The current P/E ratio of Cisco (12.00) when compared with 57.56 and 26.58 of Juniper and Lucent respectively -- indicates that CSCO stock is selling cheaper than its competitors. It is also less risky than its competitors, as it has a low beta.

Comparing technology leaders in the industry, Cisco's financials clearly indicate the well-being of the company compared with competitors. Cisco is more stable, has a huge assets base, higher Asset Turnover ratio, has captured a larger market share, has much greater liquid assets and is overall a much larger and financially sound company. With its current acquisitions, Cisco Systems not only diversifies its business but also strengthens the company's position in the market against competitors.

The above-mentioned facts allow me to consider Cisco a "Strong Buy."

Source: Cisco's Q2 FY 2013 Results: Time To Enjoy Profit Growth Coupled With Low Risk