Since I first wrote a bullish report on Cisco (NASDAQ:CSCO) here, the stock has appreciated by 11.5%. During the same time period, competitor Juniper (NYSE:JNPR) and Nasdaq went up by only 5.3% and 4.7%, respectively. I continue to believe that Cisco is significantly undervalued and represents an attractive value play. With a renewed conservative focus on acquisitions and margin expansion, the company is well positioned to gain market share.
From a multiples perspective, Cisco and Juniper do not appear cheap. Cisco trades at a respective 16.2x and 9.6x past and forward earnings while offering a low dividend yield of 1.3%. Juniper, meanwhile, trades at a respective 21.1x and 13.9x past and forward earning while having no dividend yield. At the same time, the firm has gross margins 56 basis points higher than its competitor at 67%. Analysts currently rate shares of Juniper between a “hold” and a “buy” and shares of Cisco nearer to a “buy.”
At the third quarter earnings call, Juniper’s CEO, Kevin Johnson, noted strong performance:
We achieved solid bookings in the quarter and secured important design wins that support the pipeline of new solutions we are bringing to market. The macro environment remains challenging with many economic indicators becoming more volatile in the recent weeks. In the near term, this environment may make certain customers more cautious in their CapEx spending. However, we believe our broader market opportunity continues to be strong, driven by the 2 key trends of mobile Internet and cloud computing.
In this environment, as we did in 2009, we remained focused on being agile and flexible, while making the right investments for the long-term. Looking at the customer environment, service providers continue to invest in their infrastructure. In Q3, our service provider business grew 8% year-on-year. Year-to-date through Q3, our service provider business has grown 17% year-on-year.
Shareholders of Juniper will also benefit from what I see as conservative guidance. Management is also releasing a slew of products that will increase demand and pricing power – increases to staff indicate confidence that the developments will deliver. In addition, the company’s new core router, T4000, has been speculated to receive orders from major carriers already, like Verizon (NYSE:VZ) and Comcast (NASDAQ:CMCSA). I am further optimistic about MobileNext and QFabric, which I anticipate experiencing top-line acceleration around the third quarter of 2012.
Consensus estimates for Juniper’s EPS are that it will decline by 3.1% to $1.35 and then grow by 15.2% and 19.4% in the following two years. Assuming a multiple of 17x and a conservative 2012 EPS estimate of $1.26, the rough intrinsic value of the stock is $22.95. This implies 14.5% upside and does not make the company, in my view, to be a value play. If the multiple drops to 13x and 2012 EPS turns out to be 12.5% below consensus at $1.26, the rough intrinsic value of the stock is $16.38, which implies 18.3% downside.
Overall, I believe that a stronger story exists for Cisco. The company is deriving value through a partnership with EMC and NetApp in storage and I believe that the result will be a strong unified data center product. While Cisco faces substantial risk from campus switching, it has done a stellar job in maintaining customer satisfaction for sustainable generation of free cash flow. Furthermore, margins will expand with acceleration of services over products.
Consensus estimates of Cisco’s EPS are that it will grow by 9.9% to $1.78 in 2012 and then by 9% and 8.2% more in the following two years. Assuming the multiple holds relatively steady at 16x and a conservative 2013 EPS estimate of $1.89, the rough intrinsic value of the stock is possibly $30.24 – implying a staggering 62.8% upside. Even if the multiple drops to 13x and 2013 EPS ends up being 7.2% below consensus, the value of the stock should be around $23.40. Accordingly, I strongly recommend a buy and hold strategy for Cisco.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CSCO over the next 72 hours.