Cisco: Dividend Hike Will Lead To Strong Gains

| About: Cisco Systems, (CSCO)

Cisco (NASDAQ:CSCO) reported its full year earnings results for 2012 last week. Its net income reached $8 billion for the year, marking an increase of 23.9% compared to the same period last year. This translates to earnings per share of $1.49 per share, also an increase of 27.4%. For the fourth quarter alone, net income amounted to $1.9 billion. Earnings per share for the period came in at $0.36. This represents an increase of 55.6% and 63.6%, respectively. Excluding one-off items, this translates to adjusted earnings per share of $0.47 per share. This beats consensus average analyst estimates of $0.45 per share.

The robust results are attributed to the better than expected revenue, as well as its ongoing cost savings and restructuring program. Revenues during the fourth quarter amounted to $11.69 billion, relatively flat compared to the same period last year. This brings full year revenues to $46 billion, up 6.6% year on year. This exceeds management expectations of flat revenue growth for the year.

Major business segments appear mixed. Switching revenues, accounted for 31% of the total revenues, declined by 1.1% for the fourth quarter and flat for the full year. Fixed switching grew 3%, offsetting the 7% decline in modular switching. Despite the flat growth for the full year, management remains positive as customers are switching to fixed switchers to the new Nexus 2000 and 5000 product lines. Routers revenues, accounted for 18% the total revenues, down by 2.1% during the fourth quarter but up 3.9% for the full year. The growth appears positive but the broad-based weakness will eventually impact Cisco's routers revenues for the next year. New products contributed 28% of revenues, up 4% for the fourth quarter and 6.9% for the full year. The wireless and data centers were the multiple drivers of this business. Security revenues also performed well, but the decline in content security offset its solid growth. The rest of the new products revenues like collaboration and service video provider also declined by 1.5% and 1.4%, respectively.

Cisco reported that its order book increased by 2% compared to the same period last year. The Asia Pacific Japan and China region grew 12%, while Americas also grew orders by 4%. Its European business declined by 6% in line with the current market trends. Australia continued to post among the strongest markets, while other parts of Europe significantly declined from lower enterprise and government spending. Meanwhile, its US business grew at the state and local government levels but declined at the federal level. Enterprise accounts in the US also grew.

Overall, Cisco recorded operating profit of 23.4%, up 260 basis points for the year. This means that management is on track to meeting its turnaround plan. This is also higher than the previous year's operating margins of 17.8%. I believe that the company is on its path to returning to prior years' margins of 24% to 29%. Given the company's focus on cost discipline and focus on profitable product lines, there's a big chance that it will return to its historical profitability.

Some of Cisco's peers in the networking industry are doing even worse, with the exception of F5 Networks (NASDAQ:FFIV). Juniper Networks (NYSE:JNPR) reported a decline for its second quarter 2012 earnings. Net profit during the period declined by 4% compared to the same period last year. Operating margins reached 8%, significantly lower than last year's operating margins of 13%. Intel (NASDAQ:INTC) reported a growth of 3.6% for the June quarter. Operating margins came in at 28%, also lower than the previous year's operating margins of 32%. Intel has posted operating margins as high as 35% in 2010. Even Microsoft (NASDAQ:MSFT) reported 4% growth for the quarter and 5.4% growth for the full year. This is lower than the company's expectations of 9% growth for the year. Microsoft operating margins have also declined compared to the prior year. Its margins have declined from 36% in 2007 to 29% in 2011. In contrast, F5 Networks have reported 21% growth for the quarter. Despite the robust growth, this seems slower than the previous year's 31%. Over the last 5 years, F5's operating margins have increased from 18% to 30%.

CEO John Chambers Move to Please Shareholders

During the earnings release, Cisco CEO John Chambers also announced that it will increase its dividends by 75% to $0.14 per share. The company also said that it will return half of its free cash flow to investors each year in the form of dividends and share repurchase. Based on its average free cash flow, this would amount to $4 to $5 billion a year. This translates to a yield of around 3.9% to 4.9%.

The move will definitely appease shareholders. This will give investors a reason to reconsider Cisco as an investment. While waiting for the company to completely turnaround, the high dividend yield will put a downside cap to its shares. The handsome payout will bring Cisco as among the highest dividend tech stocks in the market today. For example, generous tech stock like Intel has dividend yield of 3.42%. Microsoft has also a yield of 2.59%.

There are also concerns that the reason why management decided to increase its payout is that it expects slower growth for the next 5 years. I believe this is not the case. As mentioned above, the company has experienced growth in other businesses segments such as its data center and switches. These positive developments assure investors that cash flow will be higher in the future. I also expect that capital spending of around $1 billion a year will remain steady as it moves to invest into its growth areas. The hike in dividends is management's promise that shareholder returns will be higher in the future.


At present, the stock is trading at 9 times forward earnings. For the past five years, the stock has average earnings multiple of 17 times. The current valuation reflects uncertainties surrounding the stock.

In contrast, F5 Network is priced to perfection. It currently trades at 30 times earnings. Investors are excited over the company's prospects as a niche player in the networking space. Microsoft also trades at historical lows at 9 times earnings. Intel is valued at 10 times earnings. It seems that investors are not convinced that these tech giants will outperform in the future.

Going forward, I expect income investors to buy into a solid technology giant like Cisco. Long time shareholders of the company will find no reason to dispose its shares. After all, there is income and value in Cisco's shares. Investors get paid to wait until its share price appreciates.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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