Cisco Systems, Inc. (CSCO) is going to report Q3 2012 results on Wednesday. In the past, CSCO did fairly well in beating earnings estimates slightly which is why I am generally positive about the upcoming earnings. Yet, the stock is down more than 50% from its 2007 high. With a share price of roughly $19 the stock trades just about as high as it did in May 2009 when markets were most volatile and rising. Since then, the stock has essentially been flat. With a performance of 10.29% YTD, shareholders could at least capture some of the gains this year.
click to enlarge
So, is there a fundamental microeconomic reason why the company did poorly in terms of stock market performance?
A look at the financials reveals that the company did actually quite well over the last four years. Despite a deep recession starting in 2008/2009 revenues have exceeded the pre-recession high. Although the EBIT margin has declined from 24% in 2008 to 18% in the most recent year due to pricing weakness and high costs, the margin is still respectable given the industry's competitive pressures. The most recent net profit margin for the last financial year stood at 15% which is what I forecast as an annualized rate for this fiscal year as well. Through the recession CSCO increased earnings by a CAGR of 7.5%. So, not so bad after all.
The return on equity has been 15% as well, indicating that the company is not only capable in earning its cost of capital but to enhance shareholder value - so far the market has been mispricing CSCO.
CSCO currently has a market cap of $103bn with 44bn in cash and investments. This position has a huge margin of safety impact as this translates almost to $8 per share in cash which takes substantial risk out of the shares.
The average analyst EPS estimate for FY 2012 is $1.84 per share. I am predicting a value of $2 per share. I also consider a forward P/E of 9.6 not appropriate for a leader in its sector and consider a multiple of 15 more reasonable. The consensus target price for CSCO is $22.50, which marks an upside of 18.4% compared to 50% based on my estimates (Wall Street will catch up).
Another positive is, that CSCO in the past was hugely determined to act shareholder friendly by committing large amounts of capital to share repurchases. Share repurchases signal to investors that the company believes its shares are undervalued and are a great way to use excess cash. When additions to share repurchase programs are announced and purchases actually executed when stocks decline, the shareholder could not wish for more shareholder orientation of management.
In my opinion $19 is too low a price for a worldwide leader in data-networking equipment and software. Relying on my earnings modeling, which in its results is not far from Wall Streets estimates, an EPS of $2 a share is attainable for CSCO in 2012/2013. I have bought CSCO in anticipation of a greater market appreciation of the underlying strong fundamentals, its strong market position, its high cash value per share, proven shareholder orientation and screaming undervaluation. A multiple of under ten for a company of CSCO's format is just too cheap. Even with a weakness in the stock after the earnings release I am comfortable with the price I paid and I am going to commit more capital to buy if earnings are perceived to be weak by the market.