- Cisco Systems reported Q1 results that were weaker than expected - the company missed top-line estimates for the first time in many quarters.
- Overall, company performance wasn't bad, however, and strong points such as a compelling free cash flow conversion rate remained in place.
- CSCO is looking like a fairly-valued lower-risk pick with a solid return outlook following the steep post-earnings share price drop.
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Cisco Systems, Inc. (NASDAQ:CSCO) is a leading networking products company that has seen its shares come under pressure recently, following quarterly results that missed revenue estimates, and that included weaker-than-expected guidance for the current quarter.
Cisco is, however, still a quality company with a solid growth outlook, and shares offer a sizeable dividend yield of 2.7% at current prices. Since Cisco is also not really expensive at current prices, the stock could be of value for investors that want to buy the dip.
Cisco Stock Earnings
Cisco Systems, Inc. reported earnings results for the company's fiscal first quarter (FY2022) on November 17, reporting revenues of $12.9 billion and profits of $0.82 per share. Despite an 8% revenue increase relative to the previous year's quarter, Cisco missed the consensus estimate, as analysts had predicted a larger revenue growth rate. It should be noted that Cisco's Q1 2021, i.e., the quarter one year earlier, was not an especially strong quarter due to the pandemic impact, which is why analysts were predicting a larger business growth rebound compared to what CSCO has actually delivered during the quarter. Nevertheless, Cisco Systems' profitability was healthy during the quarter, as the company grew its earnings per share by 8% year over year.
Looking at CSCO's past performance when it comes to beating analyst estimates, we see that the most recent quarter was an outlier:
Source: Seeking Alpha
Cisco has reliably beaten estimates on both lines for many quarters in a row, but that streak was broken with the most recent report, which could explain the market's very negative reaction to CSCO's Q1 report - shares dropped by close to 10% on the day following the earnings report.
Taking a deeper look at Cisco Systems' most recent quarter, the first important point is that the company still felt some headwinds stemming from supply chain issues. Due to some component shortages, Cisco's revenue performance in the product segment was weaker than it could have been in an environment with no supply chain issues. This helps explain why Cisco's revenue performance was slightly weaker than expected. Customer demand, however, remained strong and improved considerably over the last year, showcased by Cisco's order intake:
Source: Cisco Systems presentation
Cisco experienced 30%+ order growth in all three geographic regions, and three out of four customer segments grew their orders by at least 30%. This shows that Cisco's products are still highly relevant for its customers, and the company's huge order intake bodes well for Cisco's future revenue growth, as these orders will turn into product sales and thereby generate revenue for Cisco in future quarters.
Cisco also was able to grow its recurring revenue further during the most recent quarter:
Source: Cisco Systems presentation (linked above)
Annual recurring revenue came in at $21.6 billion during the quarter, up 10% year over year, slightly outperforming the company-wide revenue growth rate. A meaningful recurring revenue growth rate that, over time, lifts the portion of Cisco's revenue that is recurring, could lead to a higher valuation down the road. Markets favor companies that have reliable, resilient cash flows, which is the case with recurring revenue models. SaaS companies are a great example of that, and even though Cisco will likely never trade at the valuations we see from cloud software players, for example, Cisco could still see its valuation expand over the years as recurring revenues become a larger part of its business. Right now, recurring revenues make up slightly less than half of the company's revenue overall, but if that portion climbs to 60% or 70% eventually, Cisco could be seen as an even less cyclical company that deserves to trade at a higher valuation compared to the one it trades at right now.
When it comes to the individual performance of Cisco's business units during the most recent quarter, we see a pretty wide range:
Source: Cisco Systems presentation (linked above)
The product category that Cisco Systems calls Internet for the Future saw revenue growth of more than 40%, while most other categories saw growth between 1% and 10%, Optimized Application Experiences being another positive outlier with a growth rate of around 20%, although from a pretty small base. The strong growth that the IFTF business experienced can be explained by strong demand from webscale (large-scale cloud computing) clients, Cisco's management states, but due to the fact that sales here can depend on individual orders to a significant degree, it is far from guaranteed that growth in this space will remain this high.
The somewhat weak performance in Cisco's Security category is a bit of a let-down, as this is one of management's strategic focus areas - growth of just 4% during the most recent period is far from great, although this can improve again in the coming quarters, of course.
Looking at Cisco's balance sheet and cash flows, we see that the company remained a very cash-rich entity. Per its 10-Q filing, Cisco held a little more than $23 billion in cash and equivalents at the end of the first quarter, partially offset by about $8.5 billion of debt (short- and long-term). Cisco thus has a net cash position of around $15 billion right now, which is quite meaningful relative to a market capitalization of $235 billion, as 6%-7% of Cisco's market value is covered by net cash. Cisco generated free cash flows of $3.3 billion during the first quarter (after capital expenditures of around $100 million), which equates to annualized free cash flows of a little more than $13 billion. Thanks to the fact that Cisco does not need to invest a lot of money in new facilities or factories, its free cash flow conversion remained excellent. When we adjust the market capitalization for Cisco's net cash position, the company is currently valued at around 17x its annualized free cash flow, which equates to a free cash flow yield of around 6%. That does not make Cisco Systems an absolute bargain, but relative to the broad market, Cisco still looks relatively inexpensive.
CSCO Stock Forecast
Cisco Systems has guided for a weaker-than-expected second quarter, as revenue growth is seen at around 5% during the current period. In Fiscal 2022, overall, Cisco expects to grow its revenue by 6% compared to the previous year's period, which is solid, although not spectacular. Since the market had hoped for better guidance, the weak share price performance immediately after the earnings release was not too surprising.
In the longer run, I believe Cisco should be able to deliver solid returns. Business growth opportunities, driven, for example, by existing cloud computing trends that result in higher demand for routing and switching equipment by Cisco's customers, should allow Cisco to grow its revenue by a couple of percentage points a year, and acquisitions could further improve the growth outlook. It should, however, be stated that Cisco is not a high-growth player and that it will likely not turn into a high-growth company in the future. Still, with revenue growth of a couple of percentage points a year, and some positive impacts on earnings per share growth stemming from buybacks, Cisco should easily be able to deliver longer-term earnings per share growth in the 5% range, I believe.
This means that, at constant earnings multiples, Cisco would deliver returns of 7%-8% once we account for its dividend payments. There is, however, also the possibility that Cisco's valuation compresses or expands over the years, which would lead to lower/higher returns for investors buying at today's price.
Since Cisco's historic median earnings multiple is pretty much in-line with how the stock is valued today, I do not believe that valuation changes will have a large impact going forward - which is why I believe that 7%-8% annual returns from Cisco are a realistic assumption.
Is Cisco Stock A Buy, Sell, Or Hold?
The answer to that question depends, at least to some degree, on one's investment goals. Cisco Systems isn't a get-rich-quick stock pick, as a 50% or 100% return in a couple of years seems unlikely. Cisco does, however, offer a reliable and growing dividend, its business remained highly profitable even during the pandemic, and thanks to a significant net cash position and strong cash flows, there is always the ability to move into new trends through M&A. Cisco also is not looking expensive right here, despite the fact that the broad market has been running to new highs throughout much of 2021.
Overall, Cisco thus seems like a lower-risk pick that could deliver solid, but not outstanding returns in the coming years - if that is what an investor is looking for, the recent dip could provide for a solid entry point. Since CSCO traded at considerably lower prices in the mid-$40s earlier this year, Cisco Systems can't really be called an outright bargain today, however. Overall, I am neutral to moderately bullish on Cisco right here and would thus call it a solid Hold.
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This article was written by
Jonathan Weber holds an engineering degree and has been active in the stock market and as a freelance analyst for many years. He has been sharing his research on Seeking Alpha since 2014. Jonathan’s primary focus is on value and income stocks but he covers growth occasionally.He is a contributing author for the investing group Learn more.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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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