Back in the dot-com era, Cisco Systems Inc. (NASDAQ:CSCO) was the biggest company in the world, predicting unstoppable earnings growth and fantastic shareholder returns. However, this dream and bubble quickly burst leaving investors with a 85% loss over the space of the year.
Indeed, even now, the company's share price is 74% below its all-time high of $79 a share in 2000.
Cisco Systems is a well known name and remains a world leader in communications technology. With a ttm P/E of 12, lower than the majority of its peers and a dividend yield of 3.3%, is Cisco an attractive investment? Can investors trust the company again?
4-Yr Compounded growth rate
Cisco has managed a CAGR of 8.4% for the last four years. Unfortunately, this is an average figure and the company did suffer a fall in revenue during 2009, (from $39.4 billion during 2008 to $36.12 billion during 2009) as the company's customers cut CAPEX spending after the credit crunch. However, this decline was soon erased as the company's revenues came in at $40 billion for 2010 - 1.6% higher than the company's revenue for 2008.
Furthermore, Cisco has managed to produce double-digit to high single digit revenue growth since 2010, which is impressive for a company of Cisco's size, with a market cap. of $110 billion.
Moreover, while the majority of companies grappled with rapidly falling earnings during the credit crunch, Cisco managed to stay strong as the demand for its products remained relatively unaffected. Over the period 2006-2012 the company's revenues grew by 64.5% and over the last ten years 2002-2012 the company's revenues have grown by 147% - or a CAGR of 10.6% a year.
The Gross Line
Most tech companies have strong gross margins and cash flows due to low manufacturing costs and Cisco is no different as the company rakes in a solid 60% gross margin on its products. This margin has remained constant during the last two years but did fall slightly during 2010 - although a 2% should not affect the company significantly, it did, and combined with a large unusual expense, the company's net income took a 16% hit.
That said, over the past four years the company's gross margin has averaged 61%.
One of the biggest surprises that lurk in income statements are unusual items and debt interest. Both can be highly indicative of a company's financial situation. For example, a company that has high, recurring unusual expenses could be trying to hide poor results, or attempting to camouflage losses as one-offs, without reveling to investors the true extent of its failings.
In addition, interest expenses and interest cover ratios can influence the company's future performance. In particular, rising interest expenses can constrict net income and a falling interest cover can signify rising debt and falling income - both of which could indicate that the company is heading for trouble in the future.
Pre-tax Income Interest Cover (Times)
Cisco has two large unusual expense charges on its balance sheet, one in 2011 and one in 2012. Together, these charges total just over $1 billion but the company is not trying to hide anything. These charges are related to the company's restructuring and are expected to total $1.1 billion, the rest of which will be included in the company's Q1 2013 results.
**(The charges are different depending on which financial website you look, my original figures from MarketWatch.com registered a unusual expense of $486 million in 2011 and $530 million for 2012. In fact, Cisco's annual report records these figures as $799 million in 2011 and $300 million in 2012; whichever way you look at it the total is $1.1 billion and the charges are still related to restructuring)**
On the interest front, interest expenses have risen 72% over the past four years and interest cover by net income has also fallen, indicating that Cisco is borrowing faster that its revenues are rising. Nonetheless, the company has still been able to cover its interest costs 16x, on average during the past four year's leaving plenty of room to spare for negative surprises.
The Bottom Line
Net Income Growth
Cisco's net income has grown at A CAGR of 9.3%, which indicates that the company could be becoming less efficient as both gross income and revenue have grown at a faster annual rate.
Having said that, net income has taken a hit from the one-off restructuring charges, which in theory should be earnings positive in the future.
Indeed, adding back in the unusual expenses related to restructuring, the company would have recorded a net income of $7,300 million for 2011, and $8,300 for 2012. Giving a net margin of 17% for 2011, a marginal decline of 6% for net income from the previous year.
So, even though at first glance it appears that Cisco is becoming less efficient and earnings are erratic, the reality is different and after on-off costs are discounted, margins and net income have been fairly static over the period.
Cash Flows & Balance Sheets
Operating Cash Flow
Investing Cash Flow
Financing Cash Flow
Free Cash Flow
Free Cash Flow as a % of Revenue
On average Cisco has converted 21.5% of its revenues into free cash.
Financing outflows have risen drastically in both 2011 and 2012 as the company has sought to return more cash to shareholders.
During 2009 and 2010 the company brought back $2.8 billion and $4.6 billion of stock respectively but this was paid for with long term debt resulting in positive financing cash flows.
Recently (2011-2012) the company has started offering a dividend, giving shareholders $700 million in 2011 and $1.5 billion in 2012. Furthermore, the company has continued its buyback operations but without issuing debt to finance them. So, with growing dividends and large buyback operations the company is returning more and more cash to investors and it appears it can afford it.
Short Term Debt
Long Term Debt
Net Debt (CASH)
Cisco has one of the best balance sheets in the S&P 500. The company has had a net cash position of $28 billion on average for the past four years, even though long term debt has risen 60% - cash has risen as well up around 40% over the same period, highlighting the company's highly cash generative nature.
Moreover, the company has plenty of short term liquidity with current assets covering current liabilities three-and-a-half times, even with inventories stripped out.
As a % of Net Income
On average, Cisco has returned 63% of its net income to shareholders over the past four years - a decent return for investors.
That said, Cisco has only been paying a dividend for two out of those four years, so there is still plenty of scope for shareholder returns.
Indeed, with such a strong balance sheet and cash generative operations, the company has plenty of room to maneuver financially and continue shareholder returns, even if the economic situation deteriorates.
Cisco Systems is a cash cow, the company is highly cash generative, has a strong balance sheet and is returning large amounts of cash to shareholders.
With its current low valuation, it appears that it could be time to start trusting Cisco again - especially as it looks like shareholders could be inline for rising cash returns.