Cisco Systems Earnings Preview: Single-Digit Organic Grower Returning A Lot Of Capital

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About: Cisco Systems, Inc. (CSCO)
by: Brian Gilmartin, CFA
Summary

Cisco trying to reposition the Switching/Routing business model of the '90s.

Most sell-side analysts think of Cisco as a mid-single-digit revenue grower, and that's not a bad thing.

The share repo has contributed significantly to the expected '19 EPS growth rate of 18%.

Fiscal 2020 estimates are expecting 11% EPS growth on just 1% revenue growth - slower than fiscal '19 (which ended July 31).

Cisco is fairly valued here in the low $50s and would be very attractive in mid $40s or on steeper market correction.

Cisco Systems (CSCO) i.e. the "Cisco Kid" has been struggling to transform their hardware-centric Switching and Routing business model the last 20 years and under Chuck Robbins, the new CEO replacing John Chambers, the former chairman and CEO of Cisco, the networking giant has met with a lot of success, but a lot of work still remains.

On Wednesday night, 8/14, after the closing bell, the Street is expecting $0.82 in EPS on $13.4 billion in revenue for expected year-over-year growth of 17% and 4%, respectively.

Let's look at EPS and revenue revisions for Cisco:

Q4 '17 (estimate) Q3 '19 Q2 '19 Q1 '19
2021 EPS est $3.64 $3.64 $3.57 $3.51
2020 EPS est $3.41 $3.41 $3.38 $3.32
2019 EPS est $3.08 $3.08 $3.07 43.04
2021 exp EPS gro rt 7% 7% 6% 6%
2020 exp EPS gro rt 11% 11% 10% 9%
2019 exp EPS gro rt 15% 18% 18% 17%
2021 PE 15x 14x 13x 13x
2020 PE 16x 15x 14x 14x
2019 PE 17x 17x 16x 15x
2021 rev est ($'s bl's) $55.5 $55.7 $55.3 $55.3
2020 rev est $53.8 $53.9 $53.4 $53.2
2019 rev est $51.8 $51.8 $51.7 $51.5
2021 est rev gro rt 3% 3% 3% 4%
2020 est rev gro rt 1% 1% 1% 1%
2019 est rev gro rt 5% 5% 5% 4%

Source: estimates from IBES by Refinitiv

I'm not sure why the Street is looking for just 1% revenue growth in fiscal 2020 which started August '19, so we'll hear more from the management team on the conference call.

Acceleration in share repurchase program

The steady EPS growth in fiscal '19 (which will end with this q4 '19 earnings report) is being driven mostly by a rapid acceleration in the share repurchase program. Again, the year-over-year EPS growth is welcome, and we'd hope it can be sustained, but it's unlikely at this level, given the size of the share repurchase program behind that growth.

Net income is only expected to rise 6% y/y this q4 '19, but EPS growth is expected to grow by 17-18%: that's the reduction in the fully diluted share count from the sharp increase in share repurchases this year.

Here is how the math works:

q4 19 estimate q3 '19 q2 '19 q1 '19
Net income ($'s ml's) $3,516 $3,454 $3,295 $3,452
y/y growth 6% 8% 5% 14%
Fully dil shares outstand 4,287 4.415 4,505 4,614
y/y growth -9% -9% -9% -8%
Earnings per share (EPS) $0.82 $0.78 $0.73 $0.75
y/y growth 17% 18% 16% 23%

Source: estimates courtesy of IBES by Refinitiv, historical data is from modeling spreadsheet

Most analysts and portfolio managers understand the above without seeing the math, but I wanted to walk Seeking Alpha readers through the difference between net income growth - which in this case, for Cisco, is mid-single-digits - and earnings per share growth, which incorporates the number of shares outstanding and has been in the high teens in fiscal 2019.

Share repurchase averages ($'s ml's)

1-year $5,683
3-year $3,341
5-year $2,609
7-year $2,314

The 4-quarter trailing average share repurchase total has been over $22 billion the last two quarters, significantly higher than anything historically.

Revenue growth by segment

Cisco revenues by segment Cisco Security segment is showing the most consistent growth, the problem is the Security segment is just 5% of Cisco revenue - it's not quite material enough yet to move the needle.

At 58% of revenue, the infrastructure platform is the biggest segment, but revenue growth looks mired in the high-single-digits - not bad - just you would hope the emerging segments within Cisco would be growing the fastest.

Although I'm unsure of who exactly made the prediction on the fiscal Q3 '19 conference call, "software and services", which were 43% of Cisco's total revenue in fiscal 2017, are expected to be 50% of fiscal '20 revenue.

Valuation

3-year avg EPS gro 12%
3-year avg rev gro 3%
3-year avg PE 16x
Price to revenue/sales 4.5x
Price to tang book 266
Price-to-cash-flow 14x
Price-to-free-cash-flow 18x
Price/cash-flow (ex cash) 12x
Price/free-cash-flow (ex cash) 18x
Free-cash-flow (FCF) yield 6%
Return of cap'l as % of free-cash 233% (no typo)
Mstar moat narrow

Summary/conclusion

The recent stock market correction has brought Cisco down into the low $50s, and as of the May 15, '19 conference call, Chuck Robbins has said that Cisco is seeing "limited impact" from the China trade and tariff issues.

Cisco is one of the growth babies from the 1990s and hit a series of highs in the low $70s and low $80s in early 2000, thus it's finally making its way back to proximity of the former all-time highs after a 20-year base.

Given the size of the recent share repurchases, I wouldn't be surprised to see some weakness after earnings, as the share repurchase plan will probably (and slowly) shrink as Cisco's outstanding "cash and equivalents" has fallen from $74 billion as of Nov. '17 when tax reform was passed, to $34 billion today, as of May '19's quarter end. (That's still a lot of coin, and Cisco has reduced their long-term debt from $30 bl to $15 bl, but "cash and equivalents" have been declining by $4 - $6 billion per quarter since tax reform passage.)

Technically, the stock has been building a 20-year base since the March 2000 peak for large-cap growth and Tech.

More conservative investors should keep an eye on Cisco as it transforms the business model from a hardware company to a software and services model.

This is the kind of stock we love for clients and will own more on any decent pullback.

Disclosure: I am/we are long CSCO. 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.