Cisco: The Stock That Finally Turned The Corner
Summary
- Will Cisco hit its target price of $50 a share?
- Will Cisco see a 2.9% revenue growth rate in 2019?
- Was it a good idea for Cisco to double its debt load?
- Could Cisco's current EPS and P/E ratio come back to haunt it?
- Why Cisco is still a buy in my book.
Introduction
Cisco (CSCO) is known for providing networks hardware such as switches and routers. They started paying out dividends in 2011. Their dividend has grown from has grown from $0.68 cents in 2013 to $1.16 in 2018.
The company recently authorized $25 million in order to repurchase its shares. The company is saying this is in large part because of the U.S. tax bill that was passed in December of 2017. They appear to have their eye on their investors and on making them happy over the next several years.
Cisco appears to be making some great moves. Since August, their stock has climbed from $30 to $44.16 a share.
Many analysts think that Cisco's stock will move up by another 11% with the target price of the stock being around $50 a share. Many investors are excited because of the relatively new CEO Chuck Robbins that took over the company in 2015.
To better understand this company and its stock, I feel that it would be good to go over the fundamentals of the company to determine if this company is a good buy and what risk should be associated when buying this company.
Fundamentals
When evaluating a stock, the two most important things that you need to look at are the earnings per share at the diluted price and the free cash flow of the company. The earnings per share at the diluted price of Cisco is sitting at $2.22 at the current time. That number has increased from $1.87 in 2013. That means that their earnings per share at the diluted price has increased by 18% in the last five years. This is a great increase without a doubt.
However, if the target price for this stock is at $50 a share then this number will have to increase in order to be able to meet those expectations. If you take earnings per share diluted price of $2.22 and multiply it towards its forward P/E ratio of 15, then you arrive at $33.30 per share. That is more than $10 below the stock's price of $44.16. This number could come back to haunt this stock in the future and it is definitely something that we will look at when we are looking at risk factors for this stock.
In 2013, Cisco was sitting on $11.7 billion in free cash flow and today they are sitting on $13.7 billion in free cash flow. That means that they have seen an increase of 17% in their free cash flow over the last five years, which is very similar to the increase of the diluted free cash flow. Once again, I feel that this is a decent increase for Cisco over this time period considering that they have been making plenty of acquisitions in this time period.
The next thing to understand is the revenue that Cisco is bringing in. In 2013, Cisco has brought in $48.6 billion in revenue whereas in 2017, it brought in $48 billion in revenue. So for all intents and purposes, the revenue has been flat or fallen slightly in the last five years. The revenue forecast is calling for a revenue growth of 2.3% this year and a 2.8% growth in 2019. If this holds true, then this stock is setting itself up to be in a better position for revenue growth than it is has been in the last five years.
Their net income increased from $7.8 billion in 2014 to $9.6 billion in 2017. This is another great sign for Cisco. This means that its net revenue has increased by 23% over the last four years.
In 2018, Cisco has increased its long-term and quarterly debt from $12.9 billion in 2013 to $25.6 billion, respectively. This means they have doubled their debt load in the past five years. This money appears to have been spent largely for acquisitions and all things considered such as their stock price almost doubling over the last two years, this added debt load was well spent.
As stated earlier in this article, their dividend has grown from $0.68 cents in 2013 to $1.16 in 2018. That is a 70% increase in the last five years. Cisco is also sitting on over $70 billion of cash that they have set aside for short-term investments.
Valuation
The next thing to look at is the P/E ratio and forward P/E ratio. Why even with companies that are showing strong cash flow as well as good EPS can still be priced too high. We are generally looking for companies that have a P/E ratio that is lower than 20. This is a good metric to tell us if this company's price is too high or not.
The P/E ratio for Cisco is now sitting at 18.63. This is considered a fair market P/E ratio for this company. For much of the last five years, the P/E ratio has been between 12-15. It has only recently shot up to 18.63. The forward P/E ratio is 15.45, which in reality is below the fair market value. It would be beneficial if the P/E ratio and forward P/E ratio continued to be above 18 in order to keep it in the fair market range.
How Cisco Is Expanding
Now let’s try to put together what all of this means. The new CEO Chuck Robbins took over Cisco in 2015. He has been trying to take the company in a different direction and attempting to bring it into the modern era per se. On January 1, 2016, shortly after he took over, the stock was sitting at $23.79 and today it is sitting at $44.16. Thus, the stock has almost doubled in value over the last two years.
Cisco is now entering new markets by investing in VoIP, video, and wireless and it is entering these markets through acquisitions. Cisco is in a transitional phase right now, as it is trying to reach into new markets so that it can increase the base of its customers. Cisco has also embraced SDN with its ACI solution and it is working on including services such as intent-based networking.
In the last two years, Cisco has bought sixteen companies. Most of these acquisitions included areas of cloud, machine learning, and security. It also bought Viptela and SpringPath in order to improve its competitive positioning. Through all of these acquisitions, Cisco hopes to significantly increase its marketing opportunities as well as increase its talent base.
Without a doubt since the new CEO has taken over, this company has increased its opportunity as it has mainly acquired all of these companies that will expand Cisco's horizons and increase its marketing base. Thus, hopefully increasing its revenue.
Cisco is looking at bringing home some of the foreign earnings because of President Trump and the Republican Congress. The House Republicans have proposed an 8.75% repatriated cash tax rate and have proposed a 3.5% tax on all other foreign earnings. If these new tax rates go into effect then Cisco will be in a good spot to bring much of it foreign cash home in order to use it for stock buybacks and dividend hikes in the coming years.
Risks
The same things that could be driving Cisco forward these past few years could also end up being its greatest risk. Acquiring sixteen companies and increasing its debt from $12.9 billion in 2013 to $25.6 billion in 2018 is in effect doubling its debt load and could come back to haunt it in the future if some of the companies it has acquired end up not succeeding, thus requiring the company to take on even more debt and raising its risk even more.
Increasing its debt load could also come back to haunt it if interest rates start to increase this year and next year. If interest rates increase then that will only add more to the company's debt load and it will take them longer to pay off that debt.
As stated at the beginning of this article, Cisco’s EPS is sitting at $2.22 with a P/E ratio of 15, which would put the stock's value at $33.30. That is almost $10 below the stock's actual value of $44.16. Although the stock is projected to hit $50 this year, there appears to be the risk that it could fall again. I do think it would have to face some significant economic headwinds in order for this to happen. However, under our current economic circumstances with tariffs being a possibility in the future as well as a possible trade war, nothing can be taken off the table.
Conclusion
Cisco seems to have turned around under the new CEO and broadened its horizons. With the purchasing of sixteen companies and its stock price nearly doubling over the last two years, the company has accomplished a lot. Cisco has accomplished many positive things such as increasing its EPS and has increased its free cash flow by 18%. Its revenues have largely remained flat over the past five years, but they are expected to increase by 2.3% this year and by 2.9% next year. The company has increased its net income by almost $2 billion since 2014. Its dividend has increased 70% over the last five years.
All in all, there are many positive things that are happening to this company right now. It appears to be finally breaking into a bull market. I do think that this company will continue to succeed and I think it is very likely that the stock price will reach $50 sometime this year.
I do doubt that Cisco will continue to grow at the rate it has grown over the last two years. I do not think its stock price will double again off its current price in another two years. It will likely settle down into a slower pace of steady growth.
I would consider this stock a buy if you are willing to understand that it might not be as bullish as it has been over the last two years. I think the stock will climb slowly, but surely over the next two years.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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