Cisco Systems: Long-Term Value Creation Remains Intact As Management Takes The Right Steps

Aug.15.13 | About: Cisco Systems, (CSCO)

Shares of Cisco Systems (CSCO) are selling off after the company released a decent fourth-quarter earnings report, accompanied by a soft guidance.

Yet the long term appeal remains as Cisco continues to grow its operations, although at a slower pace. The strong balance sheet, high payouts to shareholders, and relentless focus on profitability should ensure an investment in the company continues to pay off.

Fourth Quarter Results

Cisco Systems generated fourth quarter revenues of $12.42 billion, up 6.2% on the year before. Revenues were in line with consensus estimates which stood at $12.41 billion.

Net income rose by 18.4% to $2.27 billion as earnings per share advanced from $0.36 last year to $0.42 per share over the past quarter.

Adjusted earnings per share came in at $0.52 per share and beat consensus estimates by a penny.

CEO and Chairman John Chambers commented on the developments and immediate future, "My confidence in our ability to be the #1 IT Company is increasing. Our fourth quarter was a record on many fronts, with record revenue, and record non-GAAP operating income, non-GAAP net income, and non-GAAP earnings per share. In every case, we exceeded the midpoint of our guidance. We also generated $4 billion in operating cash flow in the quarter, another record."

Looking Into The Results..

Cisco still generates roughly 80% of total revenues from the sale of products and equipment, as product revenues rose by 6.4% to $9.74 billion. Service revenues rose by 5.6% to $2.68 billion.

Gross margins did come under some pressure. GAAP gross margins fell about 140 basis points to 59.2% of total revenues as the company is expanding into lower margin businesses. Yet I have to give Cisco a compliment in its cost cutting and execution efforts.

Absolute operating expenses fell by 3.8% despite revenue growth, and fell a whopping 380 basis points to 36.5% of total revenues. Solid operating leverage, good execution and absence of restructuring and amortization charges were the driver behind this.

..And The First Quarter

Revenues for the current quarter through October are estimated to come in between $12.2 billion and $12.5 billion. On average, analysts were expecting Cisco to guide for first quarter revenues of $12.5 billion.

The guidance implies that revenues will increase by 3 to 5% compared to the period last year, and fall short of Cisco's long term grow target of 5-7%. Yet the company remains committed to this revenue growth target and a 7 to 9% increase in non-GAAP earnings per share.

Non-GAAP earnings are seen between $0.50 and $0.51 per share, which implies that earnings will fall by a penny compared to this quarter.

Valuation

Cisco ended its fiscal year with an incredible $50.6 billion in cash, equivalents and investments. Total debt stood at $16.2 billion, for a net cash position of $34.4 billion.

Annual revenues came in at $48.6 billion, up 5.5% on the previous year. Net income rose by 24.2% to $9.98 billion, just shy of the $10 billion mark.

Trading around $24.50 per share, the market values Cisco at some $130 billion, or its operating assets at just $95 billion. This values Cisco at around 2.0 times annual revenues and 9-10 times annual earnings.

Cisco pays a quarterly dividend of $0.17 per share, for an annual dividend yield of 2.8%.

Some Historical Perspective

Long term holders of Cisco's shares have seen stagnating returns. Shares have traded in a wide $15-$30 trading range for most of the past decade. Despite Thursday's sell-off, shares are still trading with year to date gains of about 25%, trading around $24.50 per share.

Underlying the steady returns over the past year has been a steady growth of operations and increasing cash flows to shareholders.

Between 2010 and 2013, Cisco has increased its annual revenues by a cumulative 21% to $48.6 billion. Net earning rose by 29% to $10.0 billion in the meantime. On top of that, Cisco has retired 8% of its share base, and initiated a dividend which it hiked to a current dividend yield of 2.8%.

Investment Thesis

The cautious guidance comes as a surprise as Cisco and its CEO Chambers have seen increased momentum in the recovery a few months ago. Today, Chambers called the recovery, "more mixed and inconsistent [than] the other I have seen. The environment in terms of our business is improving slightly but nowhere near the pace we want."

To tackle the slowdown in revenue growth, Cisco is focusing relentlessly on execution as it will cut some 5% of its workforce, or 4,000 workers.

Cisco does this to remain lean and to be able to quickly adapt to changing customer demand and emerging technologies. Analysts are worried that the job cuts implies that softness will continue in the second and third quarter of fiscal 2014.

Yet Cisco's very strong balance sheet brings much needed support. The company has almost $35 billion in net cash, allowing it to make opportunistic and strategic acquisitions into emerging software and security business to secure revenue growth going forward. The relentless focus on cost and execution continues to boost earnings, while earnings per share continue to grow at a healthy rate on the back of share repurchases.

Just a few weeks ago I took a look at Cisco's prospects after the company announced the acquisition of Sourcefire (NASDAQ:FIRE). Shares have lost around a buck from that point in time, but I reiterate my conclusions from the time.

Backing out the large net cash position and Cisco trades at just 10 times earnings. At the same time investors receive a cool 2.8% dividend yield, while the company has already enough cash to pay out dividends at the current rate for some 15 more years! The share repurchases put a decent support under the current share price in the meantime.

It is understandable that some investors are getting the nerves after other large technology bellwethers like Microsoft (NASDAQ:MSFT), Intel (NASDAQ:INTC) and Hewlett-Packard (NYSE:HPQ), have seen stagnating or even falling share prices in recent years on the back of increased competition from smaller and leaner companies which threaten to make their products, or business model unsustainable.

Yet this scenario does not apply to Cisco, at least not yet. In the meantime the current valuation seems more than fair as the company is working aggressively to remain lean and grab opportunities from emerging technologies.

Cisco remains a solid long-term investment to my opinion.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.