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by Adam Isaac

Cisco Systems (NASDAQ:CSCO) is the world's largest provider of data networking equipment and software. Cisco products include switches, routers, network-management software and access equipment that help data communication. The company has also set foot into new markets, such as web-based collaboration, video conferencing and data center servers. In addition, the company has shown remarkable profitability recently, and its recent earnings announcement surprised most of the analysts. Cisco's year over year revenue, operating income and cash flow from operations all showed massive improvement.

In addition, the company increased the dividends and paid almost $1 billion more in dividends than the previous year. At the moment, Cisco offers $0.54 in annual dividends yielding more than 3%. However, Cisco is continuing its push for considerable growth in key business areas. Cisco is showing impressive growth, but, I have decided to go deeper and analyzed profitability, debt and cash flows of the company. For my analysis, I have used data from the company SEC filings and analyzed the performance over the past three fiscal years.

Profitability Measures:

2012

2011

2010

Operating Profit Margin

21.85%

17.76%

22.89%

Net Profit Margin

17.46%

15.02%

19.40%

ROA

8.76%

7.45%

9.57%

ROE

15.67%

13.73%

17.54%

It is evident from the table that Cisco showed a dip in profitability during 2011. The main reason for decreasing profitability was a decrease in sales coupled with the increase in competition. In 2011, Cisco sales to government and public sector slowed and resulted in lower than expected revenue growth. In addition, Cisco experienced competition from new rivals entering the networking market, such as Hewlett-Packard (NYSE:HPQ) and International Business Machines Corp (NYSE:IBM). These new rivals introduced new services to become one stop shops for technology clientele. However, due to increased focus, the firm was able to achieve impressive revenue growth for 2012. As a result, almost all of the profitability metrics showed an improvement.

Cisco operating profit margin stands at 21.85% while the industry average stands at just above 9%. Furthermore, the firm has an attractive net profit margin of 17.46%. A return on assets of almost 9% shows that the firm is utilizing its assets efficiently. In addition, Cisco offers an excellent ROE of 15.67%.

Debt Metrics:

2012

2011

2010

Debt Ratio

17.79%

19.31%

18.84%

Debt to Equity

0.32

0.36

0.41

Capitalization

24.14%

26.25%

29.32%

Interest Coverage

16.89

12.22

14.71

Cash Flow to Debt

0.70

0.60

0.67

Cisco systems total debt has remained relatively stable over the past three years. Cisco total debt stood at just above $15 billion at the end of 2010. However, the company took on more debt and the total debt went up to almost $17 billion during 2011. At the end of fiscal year 2012, total debt for Cisco stood at $16.2 billion. Cisco long term debt is almost entirely made up of long term fixed rate notes maturing between 2014 and 2040. There is only one floating rate offer, which is due in 2014 and have a maturity value of $1.25 billion. Floating rate debt obligation has an effective rate of .81%. In addition, two more fixed rate notes of $2 billion and $500 million are due in 2014, both of which fixed rate notes yield 1.625% and 2.90%, respectively.

Cisco takes adequate measures to tackle interest rate volatility regarding its debt. The Company entered into interest rate swaps with an aggregate notional amount of $4.25 billion designated as fair value hedges of certain fixed-rate senior notes. According to my analysis, the firm is in a strong position regarding its debt. Debt ratio for Cisco is manageable at 17.79% and has shown a decline from 2011. Cisco's debt ratio is quite fair, especially taking into account the massive market capitalization of the company. In addition, debt to equity ratio and capitalization ratio has shown a declining trend and currently stand at 0.32 and 24.14% respectively. On the other hand, interest coverage and cash flow to debt ratios have shown an improvement over the past three years. The tech stock should not have any problem covering its debt obligations in the near future.

Cash Flows Measures:

2012

2011

2010

Operating Cash Flow to Sales

24.95%

23.32%

25.41%

Free Cash Flow to Operating Cash Flow

90.20%

88.35%

90.09%

Capital Expenditure Coverage

10.21

8.59

10.09

Dividend Coverage

7.66

15.32

N/A

CAPEX + Dividends Coverage

4.37

5.50

10.09

Cisco demonstrates outstanding cash flows measures. The company has cash flows from operations to sales ratio of almost 25%. It indicates that the firm is converting a sizeable chunk of its sales into cash flows, indicating higher level of earnings. In fact, it is in line with my previous analysis of earnings quality of Cisco. In addition, Cisco free cash flows are attractive at more than 90% of operating cash flows. Furthermore, Capital expenditures ratio indicates the firm should not have any problems funding future expansions through internally generated cash flows. In 2012, Cisco decided to increase its dividends by 75%, which took its dividend expenditure above $1.5 billion. An increase of almost $1 billion in cash dividends decreased the dividend coverage ratio for Cisco in 2012. However, the ratio indicates that there is still enough room for the company to make changes, and it should be able to secure dividends through cash flows.

Competitors:

In comparison to its nearest competitor, Juniper (NYSE:JNPR), Cisco stock is trading at a discount. Cisco's trailing P/E is only 13, while Juniper has a trailing P/E of 40. Cisco is a recognized giant and management has given it a new direction, and I expect the company to carry on its impressive revenue growth. The forward P/E ratio of 9.33 indicates almost 40% increase in expected earnings for the next year.

Summary:

At the moment, Cisco stock is trading at a discount. There are attractive growth opportunities for the company. As far as I see, the firm is on the right path and the profitability is improving. Cisco offers reputable margins at a discounted price. The stock offers attractive dividends and I expect the company to further increase dividends. Cisco has large cash reserves which it is using to diversify and add new revenue streams to the company. In addition, the firm is returning some of the cash reserves to stockholders by increasing the cash dividends. Cisco can be a valuable dividend stock for a retirement portfolio.

Source: Cisco Demonstrates Impressive Profitability