Cisco Plunges On Terrible Guidance

Nov.14.13 | About: Cisco Systems, (CSCO)

After the bell on Wednesday, technology giant Cisco Systems (NASDAQ:CSCO) reported its fiscal first quarter results. Overall, the report was mixed. Cisco did announce an extension to its buyback plan, but issued very weak guidance that caused shares to fall in the after-hours session. Today, I'll break down the earnings report, the weak guidance, and discuss where Cisco stands in the greater investment picture.

First quarter results:

On the top line, Cisco reported revenues of $12.085 billion. This number was light, as analysts were looking for $12.36 billion. Analysts were looking for 4.1% growth, and Cisco came in at 1.8%. Additionally, analysts were expecting more growth in Q1 at the prior report, and Cisco's weak guidance for Q1 had forced estimates down from 4.9% to 4.1%. On the bottom line, Cisco came in at $0.53 per share (non-GAAP), which beat analyst estimates by two cents.

Cisco reported cash from operating activities of $2.649 billion, up from $2.465 billion in the year ago. During Q1, Cisco also completed its acquisition of Sourcefire, one reason why the company's cash and investments balance dipped by $2.409 billion. During the quarter, Cisco repurchased approximately 84 million shares of stock at an average price of $23.65.

Cisco CEO John Chambers gave the following statement in the report:

"This quarter we delivered record non-GAAP profitability and continued our steady stream of innovation and market leadership. While our revenue growth was below our expectation, our financials are strong, our strategy is strong and our innovation engine is executing extremely well. We remain confident in our long-term goal to be the #1 IT company in the world and help our customers solve their biggest business problems."

Like I said above, this report was mixed. Revenues fell short of expectations, but the bottom line beat. Non-GAAP gross margins of 63% were above expectations of 61%-62%. That helped with the bottom line beat. Now let's look at some other items from this report.

Expanding the buyback:

Cisco provided the following statement in regards to the buyback:

Cisco is also announcing that its board of directors authorized up to $15 billion in additional repurchases of its common stock. Cisco's board had previously authorized up to $82 billion in stock repurchases. There is no fixed termination date for the repurchase program. The remaining authorized amount for stock repurchases under this program, including the additional authorization, is approximately $16.1 billion.

This was a good time for Cisco to increase the buyback, as the authorized amount was getting close to zero. This expansion shows Cisco's commitment to capital returns. We recently saw Microsoft (NASDAQ:MSFT) expand its program by $40 billion. Microsoft's program was close to ending as well. Like Microsoft, Cisco did not put a time frame on when the program would be finished. Apple (NASDAQ:AAPL) also increased its buyback by $50 billion earlier this year, and Apple expects its program to be done at the end of 2015. Next up in my opinion is Intel (NASDAQ:INTC), as the chip giant could see its buyback finished up in the next year or two.

More value versus weak guidance:

Cisco completely surprised everyone by issuing awful guidance for fiscal Q2. The company said that year-over-year revenues for the quarter will decline by 8% to 10%, and earnings per share will be $0.45 to $0.47. That's well below analyst expectations for 4.1% revenue growth and $0.52, respectively. Also, Cisco stated that full-year earnings per share would be $1.95 to $2.05, well below the $2.10 analysts were looking for. Emerging market orders fell in Q1, and are not expected to pick up in Q2. China has also been challenging. The government slowdown was an issue for Cisco, and I would encourage all to read the conference call transcript for management's full comments on the issues facing this company.

In my latest Cisco article, I argued that Cisco needed to be more than just a dividend/buyback name. My position was that a decent dividend wasn't enough for investors, and the added buyback will certainly add some value to investor's minds. However, I said that Cisco also needed a bit of growth. Obviously, this "warning" for Q2 is going to put a dent in those plans, and shares were hit accordingly. I'll have more on what this means in the next section.

Comparisons with other large cap tech names:

When it comes to large cap tech, there are four horseman that have $100 billion plus market caps as well as solid dividends and buybacks. Cisco is one of the four, along with Microsoft, Intel, and Apple. The following table shows a comparison of growth/valuation/dividend numbers for each based on their respective fiscal 2014 periods. These numbers are based on expectations as of Wednesday, and Wednesday's closing prices. They don't include what we heard after the bell.

*Non-GAAP numbers for EPS and P/E.

If you were to convert Cisco's earnings (before Wednesday's announcement) to GAAP, Cisco's P/E would be somewhere in between Intel's and Apple's most likely. At that point, Cisco looked like a reasonable investment, between its growth profile, dividend, and valuation combination.

Obviously, Wednesday's bombshell announcement will change the entire picture. It is now possible that revenues for the entire fiscal year might decline, just like we are seeing with Intel at present. Additionally, non-GAAP earnings per share are forecast to decline at Cisco's midpoint. Cisco fell more than 10% in the after-hours. At the last trade, the dividend yield was 3.16%. If you use the $2 EPS midpoint, the non-GAAP P/E would be 10.76. Even if you convert to GAAP, Cisco would probably be the cheapest of the four names discussed. However, at this point, Cisco probably deserves the lowest valuation, as the growth picture is now very questionable.

Final thoughts:

Cisco shares initially declined by about 3% in the after-hours session after missing on Q1 revenues. That was despite a bottom line beat and an increase to the buyback. However, shares really started to fall, and brought down a host of other names, after Cisco guided to an awful Q2. By the time the after-hours session ended, Cisco shares were down 10.3% to levels not seen in 6 months.

So what do investors do now? Well, I think you have to see how things shake out. There probably will be a number of analyst downgrades and price target cuts, and estimates will likely be slashed. Cisco is now about 19% off its 52-week high, which I think is fair given Wednesday's report. Cisco does have a 3% plus dividend yield currently, along with a decent buyback, and the valuation is low. I don't think investors should be running out and buying Cisco right now, but I don't think it's an easy short after this fall either. My recommendation now is to see how things shake out, and I'll take another look at Cisco after the Thanksgiving holiday.

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.

Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.