Cisco: Catalysts That Make it a Buy

| About: Cisco Systems, (CSCO)

Cisco Systems (NASDAQ:CSCO) grew its net income 27% over the prior year to $1.6 billion. CSCO increased its revenue 26% YoY to $8.1+ billion well ahead of street estimates. CSCO generated first quarter FcF of $1.94 billion, excluding $1 billion spent on share repurchases.

Catalysts that make CSCO a buy:

  • One of the reasons I really like CSCO is due to its cash horde. CSCO's finances are one of the best in the industry, with over $16 billion in cash, no long-term debt, and cash flow generation that averages more than $600 million per month.
  • Another reason to be bullish on CSCO is that CSCO dominates the overall routing market, with a more than 50% share. For core routers, which have speeds of more than 2.5 gigabits per second, CSCO and Juniper Networks dominate the market, with a combined market share of over 95%.
  • CSCO's US orders grew in the upper-teens and European orders grew in the low double-digits as commercial orders improved 20%, enterprise orders were up in the mid-teens, and telecommunications carrier orders increased 23%. Scientific Atlanta orders increased 20%.
  • The company increased its routing revenue 13%, driven by robust demand for its high-end CRS 1 router, its switching revenue 15%, and advanced technologies 23%, enterprise VOIP systems and wireless network contributed to most of the increase in this segment.
  • In my view, CSCO is maintaining its dominant market position in the large network routing and switching markets, while successfully positioning itself in attractive subsegments.
  • With a dominant market share of approximately 70% of the overall Ethernet switching market, CSCO is the goto facto choice for Ethernet switches. I view CSCO large installed base as a significant competitive advantage over peers, especially in cases of modular switching solutions, where it is very difficult for competitors to displace the large modular chassis equipment.
  • Due to its reputation and related large market share Cisco products typically enjoy a price premium over the competition.
CSCO's Negatives
  • Higher revenue did not provide upside to earnings, since Cisco’s gross margin declined 250 basis points YoY and 50 basis points on a sequential basis to 64.8% and the firm’s operating income margin fell 270 basis points YoY and 150 basis points sequentially to 28.8%.
  • In fiscal 2007, Cisco will spend $4 billion on share repurchases to offset potential dilution associated with stock options. CSCO’s estimated 07 adjusted FcFis $3.8 billion, with a FcF of only 2%, substantially below the S&P 500 and other leading technology companies.
  • Investors should also look for the gross margin to narrow modestly, to about 65%, in FY 07, primarily attributable to a less favorable sales mix reflecting strong advanced technology growth, as well as the addition of Scientific Atlanta products.
  • Other factors affecting profitability include component costs, channel mix, and competitive pricing pressures.
Overall, relative to changes in earnings forecasts for its industry, CSCO is above average. In addition, the company has reported earnings that were higher than those predicted in earlier estimates which is be a positive for future earnings growth.

Related: Cisco F1Q07 (Qtr End 10/28/06) Earnings Call Transcript