Cisco Systems (CSCO) reported earnings for the fourth quarter of its fiscal year 2013 of $0.49 per share ahead of the consensus estimate of $0.47 cents a share, the direct result of increased revenue and lower operating expenses. Revenues at $12.4 billion were up 6% over the previous year and 1.6% over the preceding quarter. Product revenues at $9.7 billion (making up 78.4% of total revenue) grew 5.4% year-over-year while services revenues of $2.7 billion (making up 21.6% of total revenue) grew by 8% year-over-year. Revenues grew in most regions of the world with the exception of the Asia Pacific, Japan and China which shrank by 2.8% over the previous year. The decline in revenues from Collaboration, Security and Other Products was more than offset by the growth in revenues from other products segments such as Switching and NGN Routing. Total product orders increased by 4% over the same quarter of the previous year though they fell by 3% in Asia Pacific, Japan and China because of the prevailing economic conditions.
Cisco reported a GAAP net profit of $2.3 billion ($0.42 cents per share) compared with $1.9 billion or $0.36 cents per share in previous year. On a pro forma basis (excluding certain exceptional items), the adjusted net profit was$2.65 billion ($0.49 per share) compared with $2.26 billion ($0.42 cents) in the previous year. For the first quarter of its fiscal year 2014, the company expects revenue growth to be in the range of 3% to 5% with non-GAAP gross margin in the range of 61-62% and non-GAAP operating margin in the range of 27.5-28.5% of revenues, non-GAAP earnings in the range of $0.50 to $0.51 per share and GAAP earnings in the range of $0.16 to $0.20.
The effect on the market
Despite reporting satisfactory results, the stock price took a beating because of the lower guidance for the first quarter of fiscal 2014 and the announcement of further layoffs. During the earnings call, CEO John Chambers said that revenues for the first quarter of the current fiscal year would be between $12.2 billion and $12.5 billion against the consensus analysts' estimate of $12.7 billion and he attributed this to shrinking sales in Japan and China. During the call, he also said that 4,000 workers (approximately 5% of the workforce) would be laid off. This is on top of the layoff of 7,800 workers last year and the year before. Investors are wondering whether the work force after the layoffs would be sufficient to drive the growth forecasts.
The company derives about half its revenues from servers and routers but John Chambers wants increasing revenues from the company's ability to provide software products and services in addition to hardware and is trying to achieve this through acquisitions. In the last three years the company has spent $10.6 billion on 59 acquisitions and 9 out of the last 10 have been software companies. During this year alone, 6 acquisitions will enhance the capabilities of the company providing cloud computing services and solutions.
The company has several problems with which it must contend. For one, the slowdown in the economies of China and Japan has hit sales and, of course, this is something about which the company can do nothing. Meanwhile, competition is intensifying in the server and router business from the likes of Juniper Networks (JNPR) and Hewlett Packard (HPQ), and in cloud computing software and cyber security from formidable rivals such as Oracle Corporation (ORCL) and Palo Alto Networks Inc. (PANW). This competition has resulted in Cisco not being able to raise prices as much as it would have wanted. It also remains to be seen how successful the company is in diversifying its revenues though it continues to dominate its core market of routers and servers.
The investment thesis
The company has an extremely strong balance sheet with cash and cash equivalents totaling $50.6 billion against debt of only $16.2 billion, leaving a net cash position of $34.4 billion. Moreover, in the fourth quarter, the company generated positive cash flows of $12.9 billion from operations. The company has said that it targets growth between 5% and 7% annually and first quarter growth of around 6% which is in line with this range. This is a stock for long-term value investors as Cisco is growing slowly, but consistently, and you would be unrealistic to expect anything else. In 2013, EPS was $1.86 the creaking to an adjusted P/E ratio of just 9.7 times earnings. In addition, the dividend yield is around 2.78% and with a payout ratio of 37%, leaving plenty of room for dividend increases in the future.
The bottom line
The recent and, to my mind, inexplicable reaction of the market to the earnings announcement has created an irresistible window of opportunity to enter the stock. I consider the stock to be highly undervalued when you look at the fact that revenues are still growing and that the company continues to dominate its core market.