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The Networking and Communication Devices industry saw an average decline in revenues over the last three years. Only a few main players in the industry are able to show substantial growth in revenues namely, Cisco Systems Incorporated (NASDAQ:CSCO), Riverbed Technology Incorporated (NASDAQ:RVBD), Juniper Networks Incorporated (NYSE:JNPR) and F5 Networks Incorporated (NASDAQ:FFIV). The growth was largely driven by consumers' need for more bandwidth and businesses seeking operational efficiencies through network upgrades.

CSCO is so far the largest company in the Industry, with FY12 revenues totaling at around US$ 46 billion. The company managed to achieve an average per annum growth in revenues of 8.4% over the last three years, greater than the industry average of -3.5% but lower than its closest peers, as shown in the table below. With limited expected growth opportunities in the sector, CSCO is bound to face tough competition from its fast growing competitors. An established name in the industry, CSCO, would be required to use all its financial strength to create opportunities in order to sustain the growth achieved over the past years.

Peer Analysis

Key Stats

CSCO

ALU

JNPR

FFIV

RVBD

Industry

Rev Growth (3-year Avg)

8.40

-1.60

9.60

28.20

28.50

-3.50

EPS (NYSE:TTM)

1.73

-0.61

0.35

3.49

0.33

1.42

EPS Growth (3-Year Avg)

12.40

0.00

16.70

44.60

87.60

-

Asset Turnover

0.51

0.63

0.44

0.76

0.55

-

Operating Margin %

22.40

-11.50

7.10

30.70

11.50

9.90

Net Margin %

19.70

-9.50

4.30

19.60

6.50

7.30

ROA %

10.04

-6.03

1.88

14.89

3.75

-

ROE %

17.80

-47.40

2.60

21.80

6.80

10.10

Debt/Equity

0.30

2.00

0.20

0.00

0.60

0.30

Expected Growth %(per annum)

8.40

-26.40

16.36

17.80

22.50

-1.12

PEG

1.30

0.43

1.09

0.98

0.58

-

Dividend Yield

2.00

-

-

-

-

1.60

Source: Morningstar

As is evident from the table above, CSCO has performed better than the industry's average, and has also generally matched the performance achieved by its peers. CSCO seems to be only lagging behind FFIV which is the smallest firm amongst the selected peers, in terms of revenues and total assets.

CSCO achieved a lower growth in Revenues and EPS than its peers and this trend is expected to continue for several years into the future. However CSCO was able to post EPS of US$1.73, greater than most of its peers except FFIV which posted an EPS of US$3.49. In terms of efficiency, as measured by the Operating and Net Margins and the Asset Turnover, CSCO seems to be at par with its peers and far superior to the industry. Similarly, CSCO has also outperformed its peers, except FFIV, in terms of profitability with ROA and ROE of 10.04% and 17.80% respectively. The return achieved by the company looks even more attractive given that the risk level of CSCO is at the industry average, as measured by the debt/equity ratio.

As mentioned earlier, the company is expected to achieve growth at a lower rate than its peers, and as measured by the PEG ratio, it is expensive for investors to take benefit from this growth. However, the company is the only amongst its peers to pay dividends. CSCO has only recently started paying dividends but it has more than doubled the dividends from US$ 0.18 per share in 2011 to US$ 0.5 per share in 2012 with a payout ratio close to 19%. As the company is generating stable growth in its cash flows and with limited growth opportunities in the sector the dividends are likely to increase into the future.

Performance History

2008

2009

2010

2011

2012

Average

(5 -years)

Revenue Growth %

-8.66

10.86

7.94

6.58

3.89

Operating Margin %

23.88

20.27

22.89

17.76

21.85

21.33

Net Margin %

20.36

16.98

19.40

15.02

17.46

17.84

Asset Turnover

(Average)

0.71

0.57

0.54

0.51

0.52

0.57

Capital Expenditure

(% of Sales)

3.21

2.78

2.52

2.72

2.44

2.73

Return on Assets %

14.37

9.67

10.41

7.72

8.99

10.23

Financial Leverage (Average)

1.71

1.76

1.83

1.84

1.79

1.79

Return on Equity %

24.46

16.81

18.74

14.19

16.32

18.10

Return on Invested Capital %

19.42

12.99

13.37

9.66

11.50

13.39

Source: Morningstar

The company's performance indicators deteriorated from 2008 to 2011. However, FY12 was a good year for CSCO with all key indicators, except revenue growth, showing improvement from the figures in FY11.

The revenues of the company grew at an average of 3.89% over 5-years, with annual growth in revenues declining each year. This is a good indicator of the market conditions and growth prospects of the industry. With new entrants emerging, CSCO has been facing increasing competition in the market over 5-years and with limited prospects of growth in CSCO's core business, it is likely to get even tougher for the company to hold on to its market share. This said, CSCO has started to shift its focus towards the more profitable segments of the market. CSCO might need to run down its financial reserves in order to establish itself in new market segments. It has already started to branch out into data services sector, which is the fastest growing sector of the industry. For CSCO expansion into related markets is the only viable step to achieving greater revenue growth.

Operating and Net Margins of the company have also declined from 2008 till 2011. FY11 saw the lowest margins for the company due to increase in restructuring, mergers and acquisition expenses. Another reason for decline in margins is the gradual drop in the gross margins. CSCO's Margins increased in FY12 due to stabilizing Gross Margin, decrease in SG&A, R&D and Restructuring costs.

The company's Asset Turnover has fallen over the past few years due to decline in revenue growth and high capital expenditures. Since 2008, CSCO has considerably reduced its Capital Expenditure as a percentage of Sales from 3.21 percent to 2.44 percent. In FY12 the company has shown signs of improvement in Asset Turnover because of lower Capital Expenditure and growth in revenues. As the company diversifies into markets with greater growth opportunities, the Asset turnover ratio would likely improve.

The company's profit measures, ROE, ROA and ROIC have generally declined from the level achieved in 2008. This is largely due to substantial jumps in the CSCO's book value of equity over the years through Other Comprehensive Income. Another reason for a decline in these ratios is the fact that the company saw falling profitability margins. But similar to other indicators the company has shown signs of improvement in ROE, ROA and ROIC. CSCO has seen some tough times in recent years but its latest financial results have generally given signs of improvements, hinting towards a better future for the company.

Valuation Based on Comparables

Multiples

CSCO

ALU

JNPR

FFIV

RVBD

Average

P/E

12.00

N/A

53.50

24.86

44.15

16.10

P/S

2.40

0.20

2.30

4.81

2.84

3.99

P/B

2.00

1.30

1.40

4.93

2.66

2.20

EV/Sales

1.84

0.16

1.76

4.45

2.99

2.64

EV/EBITDA

6.03

3.13

12.88

13.31

18.60

13.68

Valuatio Matrix for TDC

Average Multiples

CSCO

Cash per Share CSCO

P/E

16.10

1.74

P/S

3.99

8.86

P/B

2.20

10.43

EV/Sales

2.64

8.86

8.70

EV/EBITDA

13.68

2.51

8.70

Equity Value per Share

CSCO

Value Based on P/E

28.01

Value Based on P/S

35.35

Value Based on P/B

22.95

Value Based on EV/Sales

29.80

Value Based on EV/EBITDA

40.67

Weighted Avg. Value

32.40

Current Price

20.75

Expected Return

56.12%

In the multiples based approach for valuation, higher weights are given to those multiples which are widely used in the investment community and are better able to capture the value of the company. Based on the above table the estimated value of CSCO's stock comes to be US$ 32.40. As it is shown in the table above, CSCO's multiples are at a discount to the industry average and also relative to its peers. The company's stock is relatively undervalued to the industry and at the current price CSCO's share provides an upside potential of 56.12%.

Conclusion

Based on the multiples approach and my overall evaluation of the company through key indicators and peer comparison, it is concluded that the company's shares are undervalued. The most recent financial results of the company have shown significant signs of improvements, in terms of increasing margins, higher return measures and lower leverage. As the company expands into more lucrative segments of the market it would be able to achieve higher growth rate in the future. The company has the financial strength to consolidate its position in the new sectors. However the fruits of the expansion may take some time to materialize. A promising future and an upside potential of 56.12% I would recommend a Long Hold on CSCO.

Source: Cisco In The Limelight