Cisco (NASDAQ:CSCO) reported 2Q16 earnings Wednesday, 2/10, after market close, and the ER was good enough to send shares up more than 7% in after-hours trading. We previewed the earnings in this article, and believe that our thesis from that preview analysis remains in-tact. We think the company remains attractively valued here and that diversified growth should continue to drive strong cash flow results. We remain long CSCO and believe shares have significant upside in a long-term window.
We believe the quarter affirms our thesis that the company is appropriately transitioning its product offerings and business focus to adapt to a cloud-dominated market. We maintain a favorable outlook on CSCO's ability to migrate its hardware business model to a software and services business model. CSCO has fleshed out its ACI business to a $2 billion run rate business that grew by over 100% last quarter. The company's security business grew 11%, with deferred revenue up 26%, and the cloud-based SaaS businesses experienced double-digit growth. As primarily evidenced by the company's recent acquisition of Jasper Technologies, management remains committed to using M&A to drive growth in cloud, security, SaaS, IoT, and analytics. We believe the company is appropriately leveraged, given its quality reputation, product diversity, and healthy operating business, to capitalize on these high-growth markets. While we remain tempered by the influx of white-label equipment, we also believe CSCO has created a quasi-moat against low-cost competitive threats through its product quality and 24x7 IT support network.
We are most impressed by the company's ability to grow free cash flow on slow revenue growth. The company has generated $6.1 billion in free cash flow through the first 6 months of this fiscal year, up 27% Y/Y, while revenues are only up 2% Y/Y. This FCF growth is driven by operating leverage and margin expansion which caused net income to grow 32% Y/Y through the first 6 months of this fiscal year.
This stellar FCF growth has shares at a similar valuation as they were pre-earnings. Going into earnings, we were attracted by the stock's ~7x EV/FCF multiple. Post-earnings, shares still sport this attractive ~7x EV/FCF multiple despite a 7%+ rally because of Y/Y FCF growth and Q/Q net cash growth.
Granted, only $3.9 billion of the company's $60.4 billion in cash is in the US, so the remainder of the cash balance is subject to repatriation taxes and should be discounted for valuation purposes. As we said in our earnings preview analysis, though, even discounting this cash an exaggerated amount (50%) gives shares an attractive valuation on a FCF basis.
With secular growth potential in the IoT, cloud, SaaS, and security spaces, we believe the company's revenue, earnings, OCF, and FCF are set to grow at a healthy rate over the next 5-10 years. Under this assumption, the current 7x EV/FCF multiple is extremely attractive and implies shares are notably undervalued. Continued buybacks and a growing dividend show us management remains committed to returning value to shareholders. We remain long CSCO and expect further share-price appreciation over the next 8-12 months.
Disclosure: I am/we are long CSCO.
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.