On Friday, I told you why I thought that Cisco (CSCO) was no longer a technology company - of course not in the literal sense. But because I have come to realize that expectations for the company differ from those of other tech names such as Apple (AAPL). On Wall Street, falling short of expectations is one thing. However, to fail when these expectations were already lowered to begin with is cause for concern. For Cisco, having seen this trend for almost a decade, I felt it was cause for dismissal - of its CEO that is. Thus I requested his letter of resignation, for which Mr. Chambers declined - and today I'm glad he did because he recently said this:
No one has Cisco's breadth of innovation, the scale and reach of our customer delivery model or our talent and experience of our employees. Cisco's value to our customers is differentiated, and it is very simple. We are globally delivering to them network-centric platforms that make them more competitive and allow them to achieve their business goals.
The quote above was said in a speech to employees late last year by Cisco's CEO. On Friday, after the stock closed at that magical $20 mark for the first time in what appears to have been "ever" it is clear that the company is delivering on its promise as stated above by Mr. Chambers.
New life in the company
The sudden resurgence in technology stocks has caused me to look again at Cisco, one of the sector's bellwethers that has been (for the most part) hanging to this title by a thread. The fact of the matter is, Cisco has failed to live up to its bellwether responsibilities for far too long and shareholders were beginning to get restless. But I now have reasons to believe that times are changing. The market is beginning to show the level of optimism needed to expect great things from a company such as Cisco, and better yet, the company is showing that it is ready to deliver.
Cisco's story is one that many (even today) still do not fully understand. The sad reality is, at one point I didn't feel that the company understood itself. It was fighting an identity crisis, while investors were trying to figure out if it was a value play or a value trap. Cisco was trying to be a growth company that didn't know how to grow. After allowing the likes of F5 Networks (FFIV), Juniper (JNPR), Hewlett Packard (HPQ) and Riverbed (RVBD) to encroach on its market share, the company had no choice but to listen to its shareholders and their demands for return on equity.
It then realized what Wall Street has been telling it all along, it had not shown that it could compete with the aforementioned companies on the same level as it once did. So management had to make some tough decisions. In order to increase profits and save the company $1 billion, Cisco laid off 9% of its workforce, It sold its set-top-box division, discontinued its Flip video camera and trimmed its consumer products line. All of which have resulted in the slimmer, trimmer company that we see today.
These are just some of the decisions it has made to show that it has rededicated itself to its routing and switching business - the core competency that originally made it a powerhouse. While at the same time, investors should not ignore that saving $1 billion a year equates to more than 5% of its operating expenses. This is an initiative that will prove (in the long run) to increase both the company's earnings and free cash flow by double-digit percentage points per year.
A couple of months ago, upon the release of Cisco's Q1 fiscal 2012 earnings, my love affair with the company seemed to have resurfaced - to the extent where I sent the company a letter of apology for having once demanded John Chambers' resignation. Since then, the stock has surged 42% from a low of $13.73 to where it sits today at $19 and my charts tell me that the stock is now heading toward $30 - a price that it has not seen since 2001. The reason for this optimism lies not only in its earnings report, but also that of some of its recent competitors.
In its Q1 fiscal 2012 earnings report, excluding some costs, profit climbed to 43 cents a share in the quarter ending October 29. Analysts on average had predicted 39 cents, according to Bloomberg data. Cisco also topped projections with its second-quarter forecast. First-quarter net income fell to $1.78 billion, or 33 cents a share, from $1.93 billion, or 34 cents, a year earlier. Sales rose 4.7% to $11.3 billion in the period, compared with an estimate of $11 billion. Cisco's gross margin narrowed to 62.4% last quarter, excluding some costs that beat the average estimate of 61.3%.
The slight drop in margin is where I suspect Chambers' quote stems from. It is clear that IBM, Lucent (ALU) as well as Brocade Communications (BRCD) have upped the ante on its core business. Considering Cisco is projecting that sales will grow 8% in the current quarter, this figure equates to $11.14 billion to $11.24 billion, beating the $11.13 billion predicted by analysts. Earnings will be 42 cents to 44 cents a share, excluding some costs. The average estimate was 42 cents.
The bottom line is, technology is once again a safe place to invest at the moment. If you want to break it down a bit further, in networking it continues to be Cisco and everyone else. Considering where the stock has risen from, I continue to think that the downside risk is very limited with respect to the cash and other strong fundamentals of the company. Its P/E is right at 10 and (to me) that implies a safer earnings risk when compared with several of its peers - namely Juniper, which might be a tad more vulnerable due to its high P/E and also the fact that Cisco has shown that it is becoming more aggressive in terms of market share and pricing.
Clearly the company is not out of the woods just yet. There are still challenges that lie ahead, but I now have several reasons to expect a continued rise not only in the company's execution but also in its share price. Even on the most bearish assumptions, this stock should easily approach the $25 mark before the end of Q2 and $30 by the end of the year.