Cisco (CSCO) has been one of those companies that holds so much promise and yet so much risk and depending how you look at it can be one to avoid or a rising star. The last the last time I took a look at Cisco, in January of this year, I could not bring myself to find anything to like about it from an investment perspective, but as I delved deeper it become a better and better investment proposition. Since then its stock price has risen by 14% in value and I believe that its upward trajectory will continue and in this article I will explain why.
I am certain that we all know Cisco designs, manufactures, and sells internet protocol-based networking and other communication and information technology products worldwide. It is a company that has been with us for some time and is the largest participant in the networking and communications devices industry with a market cap of $109 billion.
The company delivered some solid financial results for the second quarter 2012 with revenue up by 2.4% to $11.5 billion and net income up by an impressive 23% to $2 billion. For this period its balance sheet strengthened with an 80% rise in cash and cash equivalents to $8.6 billion and long-term debt remaining steady at $16.3 billion. Overall these are quite impressive results considering the current economic environment, which is seeing many businesses engage in significant cost cutting in IT and networking, to maintain margins. As Cisco's CEO John Chambers stated; "for the second quarter 2012 Cisco delivered record revenue and earnings per share."
There were also a number of key take outs, which bode well for Cisco's future performance, from the second quarter 2012 earnings reporting including that the company is successfully executing its three year plan to drive earnings faster than revenue. There is an ongoing focus on product and service delivery innovation, which is seeing more customer focused solutions being delivered leading to greater customer satisfaction, retention and market share. Furthermore, a significant achievement is that Cisco hit its billion dollar expense reduction one quarter early.
I also quite like that Cisco has expressed strong confidence in its ability to grow and deliver investor value by repurchasing during the second quarter 2012 an additional 26 million shares at an average price of $17.84 per share. This represents a total aggregate purchase price of $466 million.
Not only has Cisco delivered a solid second quarter result but it has strong performance indicators that show it is well positioned to deliver further growth and investor value through 2012, as the table below shows.
Debt to Equity Ratio
Juniper Networks (JNPR)
Aruba Networks (ARUN)
As the table shows, each of the three companies' has a double digit profit margin of 10% or greater and for Cisco and Aruba this is coupled with a solid double digit return on equity, with Cisco delivering 15% and Aruba 19%, although Juniper's is poor at 6%. However, each company has a low debt to equity ratio and when investing I have a preference for selecting companies that have low to debt equity ratios. Essentially the debt to equity ratio is a good indicator for the degree of risk that an investor undertakes when investing in a company, as the greater the degree of leverage beyond a certain point, the greater the degree risk .
I quite like Cisco's conservative debt to equity ratio of 0.34, which indicates a solid balance sheet, with the right balance between using borrowings to fund growth in operations, while maintaining them at a sustainable level. This shows the company is well positioned to weather any further economic headwinds and if the U.S economic recovery takes off and interest rates rise there should be little to no effect on Cisco's cash flow and profitability.
While these indicators give us a snapshot of the performance of the company, especially in comparison to its competitors, investors need to recognize that they only show us how the company has performed. Therefore, to get a solid feel for whether the company is cheap in comparison to its competitors, it is important to get a feel for its future valuation and determine whether at current prices, combined with consensus future earnings, it is expensive in comparison to its competitors.
Cisco has a 2012 consensus EPS of $1.84, which with a current trading price of around $20, gives it a forward PE of 11. Juniper is trading at around $21 with consensus 2012 EPS of $0.94, giving it a forward PE of 22. This makes Juniper appear very expensive in comparison to Cisco. Aruba, has a consensus forecast 2012 EPS of $0.64, which with a current trading price of around $22, gives it a forward PE of 34, which makes it the most expensive of all three companies. Based on their forward valuations, Cisco certainly looks the cheapest of the three, and represents an investment opportunity with a forward PE of 11.
As a result of Cisco's strong second quarter 2012 results, the company announced on February 7, 2012 that it has declared a quarterly dividend of $0.08 per share. This is a two cent increase per share over the previous quarter's dividend. The dividend is to be paid on April 25, 2012, with an ex-dividend date of April 5, 2012. This gives Cisco a dividend yield of around 1.6% with a payout ratio of 19%. As a quick and dirty measure of dividend yield sustainability it is highly likely that Cisco can maintain this yield. Furthermore as profits grow it is likely that we will see increases in the dividend payment as driving shareholder value is a key plank in Cisco's growth strategy and the important of this can't be overstated enough as in the past Cisco has failed to deliver shareholder value.
However, the good news is that Cisco's management have realized the company's past mistakes over the last few years as evidence by its restructure, which included closing down its Flip business unit. This particularly includes recognizing that the company took its eye off the ball by losing strategic direction and attempting to diversify into consumer markets, where it lacked any competitive advantage. This also saw Cisco fail to jealously guard access to its industry allowing small upstarts to get into the game when they should not have been able to.
Yet, management's renewed focus and implementation of a strategic growth strategy that is leveraging off Cisco's key strengths and size bodes well for further shareholder value. This has included introducing a new framework that combines the foundational elements required to enable organizations to build, manage and connect public, private and hybrid clouds. Cisco has also improved and added new services to its unique connected grid portfolio that helps utilities modernize the electric grid and increase operational flexibility, security, interoperability and scalability.
This strategy has seen Cisco make a renewed focus on strengthening its customer relationships, which has seen Cisco expand the size of its customer base for specific product and service offerings. A good example of this has been in just over two years gaining 10,000 customers worldwide for its new unified computing system.
There have also been a number of other specific successes, including Verizon (VZ), when extending its next generation 100G capability, utilizing Cisco's CRS-3 Carrier Routing System platform. It has also seen Canada's Woodstock Hospital choose a Cisco medical grade network for its new facility. Furthermore, Petrobras (PBR) one of the largest integrated oil companies in the world has adopted Cisco's Cius technology as part of its gas station of the future technology. The Dutch service provider KPN has also chosen the Cisco CRS-3 multi-chassis carrier routing system to be deployed at the heart of KPN's internet peering network. Finally, Cisco has entered into an alliance with Swisscom (OTCPK:SCMWY) to equip 200 pharmacies in Switzerland with Cisco TelePresence a video communication system.
Cisco is a dominant industry player, with advantages in scale that other industry participants are unable to compete with, which in conjunction with Cisco being the accepted IT industry gold standard gives Cisco a considerable edge in maintaining its market share. It also provides Cisco with the opportunity to leverage off those relationships to grow market share as well as creating confidence among current and prospective clients that Cisco is capable of delivering a stable and up to date networking solution. Cisco also has strong business alliances with a number of major business service companies including IBM (IBM) and Accenture (ACN), which means it is highly likely that Cisco will be the recommended IT partner of choice for any businesses utilizing their consulting services. Therefore, it is clear that Cisco is well positioned to grow its business and market share allowing it to deliver increasing investor value over the short to medium-term.
Overall, Cisco is certainly shaping up to be a solid investment opportunity that based on its recent history of poor performance the market has priced for disaster. Cisco with a renewed focus on its core business, a solid balance sheet with over $7.7 billion in cash, a strong growth strategy and a moderately cheap forward PE of 11 presents as a solid investment opportunity.