Sentiment Negative on Cisco Prior to Earnings

| About: Cisco Systems, (CSCO)

Cisco (NASDAQ:CSCO) has been riding a rolling wave of negativity for over a year. It seems like every earnings release is followed by a precipitous drop in stock price. Even so, this is a very big earnings release for Cisco, as it follows a major shake-up and restructuring announcement last month. With all the swirling opinions surrounding Cisco, I thought it might be beneficial to take the pulse of the market in terms of what people are thinking and saying about Cisco prior to its earnings.

Analyst Sentiment

It should be no surprise that Cisco, according to MotleyFool, is the most watched communications equipment stock in the world. Watch interest is at 64%, with the next closest company Riverbed Technology (NASDAQ:RVBD) being 8%. With earnings coming out on Wednesday, the spotlight will be hotter than ever.

Citigroup’s (NYSE:C) John Slack recently reinforced his hold rating on Cisco while cutting his price target to $17.50 from $20.00. The issue, he says, is that the restructuring plans are too vague. Until there is a clearer picture of a long term strategy for Cisco, it won’t matter how many jobs it cuts. John said last week that he was worried Cisco could become:

A perpetual restructuring megacap tech story. We don’t believe the stock works until we get a clearer picture on what Cisco’s long-term growth strategy and operating model [is].

Hopefully the earnings call will give Cisco CEO John Chambers the platform to further communicate some of these details. Additional context around the IT industry is also lending negative weight to Cisco. The recent calls from Juniper (NYSE:JNPR) and Brocade (NASDAQ:BRCD) have both brought light to the weakening IT infrastructure spending in both corporate and federal sectors. Brian Marshall, an analyst from Gleacher & Co. (NASDAQ:GLCH) said the scope of the weakness in corporate IT remains unclear. However, he agreed that there is some:

Weakness in the macro environment [that is] clearly impacting IT spending on the margins now. [Now we’re] seeing it in smaller customers, [but it is yet to be seen whether] it will spill over to the big boys.

So, even though there have been some negative earnings recently, some analysts are unsure whether weakness in corporate and federal IT spending will spill over to the larger companies. Again, Cisco’s call will shed some light on whether this is the case.

Cowen Group's (NASDAQ:COWN) John Marchetti recently held his neutral rating and expects Q4 earnings will be in line with estimates of $10.96 billion in revenues and $0.38 EPS. John mentions the commoditization of switching products, along with increased competition and pricing in that arena. He said that:

With the switching business commoditizing and competition increasing across multiple product segments, we believe top-line growth will be limited to the mid-single digits for F2012. For F1Q12 (Oct), we forecast low-single digit YoY growth as we expect little positive change in the switching business over the near term due to competition, pricing and ongoing product transitions. We believe Cisco can maintain a mid-20s operating margin and expect the company to unveil a new target operating model at its analyst day in early September.

So, all of these analysts seem to be pointing to the lukewarm camp for Cisco systems. A couple of weeks ago, Goldman Sachs (NYSE:GS) was in the bull camp, claiming that Cisco had a $21 price target. It mentioned that it was not a “broken franchise,” and that surveys had indicated its customer franchise was still very solid. Goldman Sachs is also claiming that the restructuring will save more money than some are projecting, with 5-10 percent added to its fiscal 2012 estimates. With the cuts, Goldman sees Cisco recovering after four straight quarters of guidance reductions and S&P underperformance of over 40%.

So, there is some difference of opinion between analysts from reputable firms. There is a price target from some hovering around $17, with Goldman standing as a lone bull at $21. Even so, these targets offer upside from the sub $15 that Cisco closed at on Friday. Its earnings on Wednesday should offer insight into which camp will be better off.

Recent Competitor Guidance

Juniper recently offered weak guidance and lower than expected earnings. I’ve covered that in a previous article here. More recently, Brocade Communications reduced its outlook and made comments indicating a slowing spending environment. This is creating even more uncertainty in a skittish market still reeling from the debt ceiling and subsequent US debt downgrade. Brocade mentioned that earnings were softened due to:

Weaker-than-expected storage end-user demand [and] lower-than-expected federal revenue, as well as a softer-than-expected IT spending environment.

These statements sent storage stocks into a tailspin and also made it seem more likely that networking stocks were in trouble. Brian White, an analyst with Ticonderoga Securities, recently made a statement that could have implications for more than just networking stocks if it ends up being accurate. Brian said that Brocade’s statement:

Casts a negative sentiment on all IT stocks. We have highlighted our concerns regarding IT spending in light of a weakening global economic environment and Cisco was early in flagging these trends last summer, especially in the public sector. It’s becoming a pretty broad-based weakness in technology. The question is, does it take another leg down or is this just a near-term softness?

So, are these recent releases a soft patch or a leg down? I would argue for the latter, as there don’t seem to be any signs of weak spending increasing or the economy being able to grow fast enough to stimulate additional investments.

Cisco will release earnings on Wednesday that should help the market figure out what is going on. Last summer, it was prophetic in its guidance that spending would slow down over the next year. Now, similar companies are suffering from those predictions being accurate. The sentiment on Cisco is mostly negative, with the exception of Goldman and a few other analysts.

Additionally, Cisco has more of a spotlight than ever before. It will be under the microscope, and the statements the company makes in its earnings call will be pored over by markets hungry for insight into projected spending. I’m looking forward to Wednesday to provide more information on what to expect over the next year.

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