Cisco: Strong Capital Returns To Shareholders Will Continue

| About: Cisco Systems, (CSCO)

Summary

Cisco has strong cash flow generation.

The company's balance sheet is extremely strong.

Cisco can continue to return capital to shareholders at a healthy rate.

With a market capitalization of $152 billion, Cisco (NASDAQ:CSCO) is one of the largest companies on the planet. Forbes recently ranked it as No. 63 in its "World's Largest Companies 2016" listing. Normally with large companies, growth starts to stagnate due to the law of large numbers, but with Cisco, the numbers continue to increase. Granted, they are not growing nearly as quickly as they were back in the '90s during the internet boom, but they are still growing and producing large amounts of capital.

The lifeblood to any company is cash, and Cisco's operations consistently provide cash flow. Since 2007, revenues, operating income and net income are all up more than 40% each. That's good for ~4% annualized growth. Not too shabby when compared to GDP growth in the US, which has averaged less than 3% since 2007. Even better is the fact that Cisco has a fortress-like balance sheet with $65.7 billion of cash set against $24.5 billion of long-term debt and $4.1 billion of short-term debt. This effectively gives Cisco an enterprise value of $115 billion (market cap - cash + debt). I love seeing enterprise values below the market cap, as it shows the financial stability of the company in question through its strong balance sheet. It also typically shows that the management of the company has many options to either return more capital to shareholders through dividends and buybacks or to bolster the company through acquisitions. Cisco has been doing all of the above. The company has a dividend that has grown by 333% from its first dividend of $0.06 in 2011 to its current payout of $0.26 per quarter. It has also reduced diluted shares outstanding from 6.265 billion in 7/07 to just over 5 billion as of the most recent quarter (7/16). That's an almost 20% decrease in shares outstanding in nine years. In addition, Cisco has announced the purchase of many companies over the years in order to bolster its offerings.

Cisco

2007-07

2008-07

2009-07

2010-07

2011-07

2012-07

Revenues

34,920

39,540

36,120

40,040

43,220

46,060

Operating Income

8,621

9,442

7,322

9,164

7,674

10,060

Net Income

7,333

8,052

6,134

7,676

6,490

8,041

Shares

6,265

6,163

5,857

5,848

5,563

5,404

EPS

1.17

1.31

1.05

1.33

1.17

1.49

Dividends

0.00

0.00

0.00

0.00

0.12

0.28

Free Cash Flow

8,853

10,821

8,892

9,165

8,905

10,365

Click to enlarge

5 yr.

9 yr.

Cisco

2013-07

2014-07

2015-07

2016-07

CAGR

CAGR

Revenues

48,610

47,140

49,160

49,250

3%

4%

Operating Income

11,200

9,345

10,770

12,660

11%

4%

Net Income

9,983

7,853

8,981

10,740

11%

4%

Shares

5,380

5,281

5,146

5,088

-2%

-2%

EPS

1.86

1.49

1.75

2.11

13%

7%

Dividends

0.62

0.72

0.80

0.94

51%

Free Cash Flow

11,734

11,057

11,325

12,424

7%

4%

Click to enlarge

* Data compiled by author from data using YCharts

With around 5 billion shares currently outstanding and a $0.26 quarterly dividend payout, this equates to around $5.2 billion in dividend payments yearly. The company easily has this covered with its free cash flow, which has averaged around $11.6 billion in the last three years (~10% free cash flow yield based upon EV of $115 billion). This gives Cisco roughly a 45% dividend payout ratio. It also announced a $15 billion share buyback plan back in February of this year, using which, at the present share value of ~$30 per share, it could buy back roughly another 10% of the company. This is how Cisco has grown net income by a CAGR of roughly 4% over the last nine years, but EPS has gone up by almost double this at 7% - by buying back a large amount of shares. In fiscal year 2016, Cisco paid out 70% of its free cash flow and returned $8.7 billion to shareholders. It has also repurchased shares at what seem to be good prices (below the current price of $30). The below comes from the company's recent earnings announcement on 8/17/16.

"For the fourth quarter of fiscal 2016, Cisco repurchased approximately 28 million shares of common stock under its stock repurchase program at an average price of $28.70 per share for an aggregate purchase price of $800 million. For the full fiscal year, Cisco repurchased approximately 148 million shares of common stock under its stock repurchase program at an average price of $26.45 per share for an aggregate purchase price of $3.9 billion. As of July 30, 2016, Cisco had repurchased and retired 4.6 billion shares of Cisco common stock at an average price of $21.04 per share for an aggregate purchase price of approximately $96.6 billion since the inception of the stock repurchase program. The remaining authorized amount for stock repurchases under this program is approximately $15.4 billion with no termination date."

One of the negatives of being a multinational corporation is that much of the cash Cisco produces is overseas. As of its last earnings report, the company had $5.9 billion available in the US (9% of its cash). It can't bring that cash back to the US in the form of dollars without paying high taxes. So, instead of repatriating funds and paying high taxes, the company has issued debt. On 2/22/16, Cisco issued $7 billion of bonds. The notes were sold in six tranches and bear interest at rates from ~1.40% to 2.95%. This seems like a beneficial arbitrage opportunity to me - issue bonds backed by overseas cash, and buyback shares paying a ~3.5% dividend yield and payout interest of ~2.2% before tax.

At the end of the day, Cisco is going to continue to produce large amounts of cash and pay out a large percentage of that cash to shareholders through dividends and share repurchases. The company will also continue to buy companies that it views as strategic fits. Cisco will probably not be able to grow its top line at large rates given how large the company is, but so long as you are fine with a company that has a fortress-like balance sheet (enterprise value below market cap), continues to return capital to shareholders (~70% payout ratio, including dividends and buybacks) and has a high free cash flow yield (~10%), I believe Cisco should be near the top of your list of companies to buy.

Disclosure: I/we 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.