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Summary

  • Cisco has hit a rough patch and its upcoming earnings report might not bring much relief to investors.
  • Cisco's declining business in the emerging markets is a big cause for concern, and Alcatel-Lucent seems to be making the most of Cisco's weakness by winning more deals.
  • Cisco is pinning great hopes on the Internet of Things, but the company's earnings projections suggest that this won't bear fruit any time soon.

Networking giant Cisco (NASDAQ:CSCO) has been weak over the past six months. The company's shares have dropped close to 2%, as it is seeing weakness in the business. In fact, in December last year, Cisco cut its three-to-five-year growth forecast to just 3% to 6% from the earlier expectation of 5%-7% growth. Cisco management is of the opinion that it will need to improve its business model going forward if the company is to turn its business around, especially in light of competition from the likes of Alcatel-Lucent (NYSE:ALU).

As such, when Cisco reports its third-quarter earnings on May 14, investors shouldn't be too hopeful. Let's see what is expected from Cisco and why it isn't a good idea to bet on Cisco even if it comes out with flying colors in its earnings report.

The expectations

Analysts expect Cisco to post revenue of $11.36 billion for the third quarter. This would be a decline of 7% from the year-ago period. In addition, Cisco's earnings are expected to decline from $0.51 per share in the year-ago quarter to $0.48 per share in the third quarter.

Hence, a weak performance is expected out of Cisco, and it comes as no surprise given the wide-ranging difficulties that the company is facing in its business. Even for the full fiscal year, Cisco's earnings are expected to fall to $1.99 a share from $2.02 last year. The same trend is seen in the revenue, which is expected to decline 4.50% this fiscal year. Thus, the situation for Cisco is quite grim and in my opinion, we won't see a turnaround any time soon.

The difficulties

Cisco's revenue in the second quarter was down 7.4% to $11.2 billion versus $12.1 billion in the same quarter a year ago. The drop in revenue was a result of a huge decline in Cisco's business in the emerging markets. Key regions such as China, Brazil, and Russia were down 18%, 25%, and 30%, respectively, for Cisco in the second quarter. Asia Pacific sales were down 4%.

This trend could be expected to continue going forward as Cisco is facing a confidence crisis in the emerging markets after the NSA spying debacle. According to MarketWatch --

"A Chinese media report quoted former National Security Agency contract Edward Snowden as saying the U.S. government used Cisco Systems Inc. routers to spy on Chinese networks. The report on the Chinese-language site Techweb.com, dated Tuesday, also said that Cisco had been involved in many major Chinese Internet infrastructure projects, including those of military and government networks."

As a result, it won't come as a big surprise if Cisco's business in the fast-growing emerging markets continues declining after a 12% crash in the second quarter. In comparison, analysts were expecting a pop of 6%.

Cisco's fall from grace in the emerging markets could open up a big opportunity for Alcatel-Lucent to capture more market share. The advantage that Alcatel enjoys is that it is based in France, so the shadow of the NSA spying scandal doesn't loom on its head.

Alcatel recently won the contract to deploy an undersea communication cable between Europe and Southeast Asia. This cable will be 20 times more capable than the existing ones, and will run from Singapore to France. The 20,000-km cable will be the longest in the world and will have a capacity of 24 terabits per second, connecting cities spread across 17 countries, including the likes of India and Saudi Arabia.

Also, Alcatel was recently chosen by YooMee Africa, which is a wireless broadband operator in Cameroon that owns licenses in several countries in Africa, for its equipment needs. According to the press release --

"Alcatel-Lucent will enable YooMee Africa, the leading high-speed Internet service provider in Cameroon, to expand into new African markets by offering TDD LTE ultra-broadband wireless access."

This further suggests that Alcatel is making the right moves in the developing world while Cisco is falling behind.

Internet of Things won't be a savior, for now

Cisco is betting big on the concept of Internet of Things. With the Internet of Things, Cisco is planning to make the world a more connected place, where physical objects can communicate with each other. More specifically, the Internet of Things is the network of physical objects accessed through the Internet.

Cisco is betting big on this market, expecting it to be worth $19 trillion by 2020, with more than 50 billion devices connected to the Internet. However, the Internet of Things is still in its infancy and Cisco has started its moves into this market with a meager investment of just $150 million. Moreover, considering the size of the opportunity, Cisco's earnings should have been expected to grow at a rapid rate going forward. However, this isn't the case.

Over the next five years, analysts expect Cisco's earnings to grow at a CAGR of just 8%. In comparison, during the last five years, Cisco's earnings had increased at a rate of more than 10%. So, despite the presence of such a big opportunity, not a great deal is expected from Cisco if we take a look at its potential earnings growth.

Conclusion

Cisco's revenue was down almost 8% in the second quarter, while its earnings were down a whopping 55%. The same trend is expected to continue in the third quarter, and it won't be surprising if Cisco's performance deteriorates further in light of the troubles that it is facing. Hence, investors should consider staying away from Cisco even if it manages to come out with a solid earnings report since its long-term prospects are shrouded in uncertainty.

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.

Source: Stay Away From Cisco Going Into Earnings

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