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By Cagdas Ozcan

Cisco Systems (NASDAQ:CSCO) is one of the most popular stocks in the market. As such its business moves are widely followed by a loyal set of investors. In particular, many investors are concerned with the dividend prospects of the company.

Cisco does not have a long history of dividends. The company paid its first dividend in April 2011. However, in the past two years, the company has increased dividend payments twice. Is Cisco the right choice for dividend growth investors? In order to assess the dividend stability and future growth of dividends, we used our free cash flow model to see the trend in free cash flows and debt metrics. Results of the model are discussed below:

Free Cash Flows:

Free Cash Flows

2012

2011

2010

Net Income

$8,041

$6,490

$7,767

Depreciation and Amortization

$2,602

$2,486

$2,030

Funds from Operations (FFO)

$10,643

$8,976

$9,797

change in noncash current assets

$469

$2,884

$2,965

change in noncash current liabilities

$379

$1,820

$2,136

Operating Cash flows

$11,491

$7,912

$8,968

Capital Expenditures

$1,126

$1,440

$6,287

Free Operating Cash Flow

$10,365

$6,472

$2,681

Figures taken from SEC filings

As it is evident from the table above, Cisco has strong free operating cash flows. In the past three years, the company has experienced some volatility in its net income. At the end of 2010, Cisco's net income stood at $7.7 billion, which went up to over $8 billion by the end of 2012. The same trend is apparent in funds from operations, and the current sum stands at a spectacular $10.6 billion. The cash flows from operations stand at substantially improved levels in 2012 as compared to 2010. At the end of 2010, cash flows from operations were $8.9 billion, which jumped up to more than $11.4 billion by the end of 2012. The firm has been successful in converting most of its sales into cash flows indicating high quality of earnings.

Cisco invests a substantial amount of funds in the capital expenditures; however, capital expenditures have decreased in the past two years. At the end of 2010, the firm spent $6.28 billion in capital expenditures, which came down to $1.126 billion by the end of 2012. As a result, free cash flows have improved over the past three years. Free operating cash flows were the highest in 2012, due to high levels of cash flows from operations and a decrease in capital expenditures. In the meantime, Cisco has also been active on the acquisitions front and has made significant acquisitions in the previous two years.

Essential Ratios:

Essential Ratios

2012

2011

2010

Funds from Operations(FFO)/Total Debt

0.65

0.55

0.80

FFO/Capital spending requirements

9.45

6.23

1.56

Free Operating Cash Flow + interest expense/ Interest expense

18.39

11.31

5.30

Debt Service coverage

17.48

4.83

2.41

For my analysis, I have used four ratios. FFO to total debt ratio shows that the debt of the company is adequately covered with the FFO. Cisco's funds from operations are in a healthy state right now, and ratio has improved over the past year after falling down to 0.55. It shows that Cisco's funds from operations cover 65% of the total debt of the company. Furthermore, capital spending requirements should be easily met by the company as the ratio shows that trend is very strong.

As it is clear from coverage ratios, the debt situation of the company is adequately covered, and there should not be any trouble in the foreseeable future. Interest coverage ratio is extremely strong for Cisco; in fact, the ratio has improved substantially over the past two years. The same is true for the debt service coverage ratio. Over the past two years, debt service coverage ratio has also shown massive improvement. A sudden increase in the ratio during 2012 was due to an increase in free cash flows and a decrease in short-term debt.

Summary:

CSCO Dividend Chart

CSCO Dividend data by YCharts

Our analysis indicates that the trend in free cash flows and debt metrics is extremely impressive. The company has been able to increase its free cash flows over the past three years. Furthermore, Cisco's recent acquisitions in the cloud computing should allow the company to increase its revenues and cash flows over the next few years. As a result, we believe there will be healthy growth in cash dividends of the company. At the moment, Cisco is an ideal investment for value investors.

Source: How Safe Is Cisco's Dividend?