Why Cisco Is Heading To $30

| About: Cisco Systems, (CSCO)

Summary

There is still plenty of untapped value here. But it's going to take some time.

With the stock trading down 5% over the past 12 months, there is a presumption that Cisco can no longer grow.

To the extent that Cisco can return to its long-term revenue growth rate of 5% to 6%, this stock should reach $30 in the next 12 to 18 months.

Although I no longer own the stock, I find myself coming to the defense of Cisco (NASDAQ:CSCO) quite a bit. Questions have been raised regarding management's focus. And there seems to be a consensus among investors that the network giant has abandoned growth.

Admittedly, these concerns are legitimate. Back in December, while citing lack of visibility in the economic environment, CEO John Chambers cut the low end of the company's revenue growth estimates for the next three to five years from 5% to 3%. The Street was shocked, if not grossly disappointed, especially since Cisco had not cut its long-term outlook since 2011. Making matters worse, again in February, not only did Cisco report a 7.8% drop in revenue, the company also delivered its lowest product gross margin (58.8%) in more than a decade.

Some investors believe that the company is losing market share to (among others) Juniper (NYSE:JNPR) and F5 Networks (NASDAQ:FFIV). When, in actuality, Cisco is suffering from the same issues affecting once high-flyers like Intel (NASDAQ:INTC) and Microsoft (NASDAQ:MSFT), which have struggled to preserve market share amid consumer shifts to new and cheaper technologies. That doesn't mean, however, that Cisco has underperformed.

Consider, despite the recent struggles, the company has now strung together ten consecutive earnings beats. In its latest quarter, Cisco reported earnings per share of 47 cents, excluding items, on revenue of $11.16 billion. The company beat consensus earnings estimates of EPS of 46 cents on $11.03 billion in revenue. Management also raised the company's quarterly dividend to 19 cents from 17 cents a share.

Despite this recent string, Cisco stock is down 12% over the past nine months. Although Cisco is no longer posting the sort of numbers achieved at the height of the dotcom era, management has not forgotten how to lead. Their challenge today is to inject investors with confidence. This begins Wednesday.

Not only must Cisco deliver another beat, but CEO John Chambers, who has come under fire lately, has to guide with the sort of conviction to get investors to believe that the company is not abandoning growth. And with enough patience, Cisco will prove to be the strong dividend play that I believe it has become, and not the value trap the Street believes it is.

The Street will be looking for earnings per share of 48 cents on revenue of $11.38 billion, which would represent a year-over-year revenue decline of 6.8%. But the expected revenue decline is hardly a surprise, given the December guidance.

What's more, investors have to realize that the entire sector, including Juniper and Riverbed (NASDAQ:RVBD), has underperformed due to shrinking enterprise budgets. Cisco, which has always had a dominant market share in routers and switches, the company has struggled amid the arrival of cheaper software alternatives. These routers and switches, which direct Internet traffic, account for almost half of Cisco's revenue.

Complicating matters, enterprises are now shifting their focus towards the cloud and outsourcing their networking needs. This means corporations no longer need to build their own data centers, which was once the driving source of Cisco's growth. Management has countered this weakness by aggressively discounting some of hardware, which pressured both revenue and near-term margins. I think it will be a stretch to assume much divergence this quarter.

Investors need to be smart, however. There is still plenty of untapped value here. But it's going to take some time. With the stock trading down 5% over the past 12 months, there is a presumption that Cisco can no longer grow. And it is this lack of confidence in a strong dividend payer that makes this stock safe. To the extent that Cisco can return to its long-term revenue growth rate of 5% to 6%, this stock should reach $30 in the next 12 to 18 months.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Wall Street Playbook's tech sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.