Cisco Systems, Inc. (NASDAQ:O:CSCO) has been a consistent performer delivering top-line revenue as well as bottom-line earnings in line with the Street expectations. Even at times of the market movements, be it uptrend or downtrend, its gains or loss would have only been limited or restricted. The second quarter results for the company were better than expected and the forecast also came in above the predictions. However, there are some investors, who believe that bears could return to haunt the stock while others predict bullish factors can overcome them. Let’s look at both the bears and bulls before concluding.
Bear Case
Weakness in Switching Division In 2Q
One of the factors that everyone point out is the switching division of Cisco. The concern about Switching is because the revenue represented nearly 30% of the total revenue and was the biggest single revenue generator for the company. Therefore, any weakness in it is bound to impact the bottom line. In the second quarter for which results were announced on February 10, the networking switch maker reported a 4% drop in revenue to $3.48 billion. It was not just one quarter that the company suffered the fall. In the last few years, its performance of switching division has been patchy. Management blamed the uncertainty in the global economy as IT purchasing managers have become somewhat cautious. Investors are haunted by concerns about big clients using white label products and the affect of businesses moving to the cloud and no longer being concerned with the devices.
Data Center
Another bear case for Cisco was the Data Center performance that gives concern to investors. It appears that the segment is also affected by the ambiguity in the economic conditions around the world. Though the division has reportedly witnessed 24% growth in January, the second quarter results indicated 3% fall in revenue to $822 million. On a Quarter-over-Quarter basis, data center revenue witnessed a 5% drop. This was contrary to its strong results after its inception.
More Revenue From Service Than Software
If reports are true, Cisco gets $11 billion revenue from Services while revenue from software totaled $9 billion last year. That might mean that the company might face margin pressures though it was not a compulsory one. Similarly, there were other factors like weakening operating margin of 34.0% versus 34.0%, and the three-year average net income growth of 3.8% compared to the industry average of 15.4%. Also, the stock valuation relative to sales for the trailing twelve month (TTM) period was 2.7 time whereas the industry average was only 1.4 times.
Bull Case
Consistent Share Repurchase Help
One of the factors that helped Cisco was the share buyback program. During the five-year period, the company was able to reduce its outstanding share by 8% thus providing investors an additional gain of more than 10%. The company also has $15 billion towards share repurchase program, which excluded the remaining portion of the previous authorization. That meant the network switch maker could reduce its outstanding shares another 10%plus. Therefore, when the current share repurchase program ends, the company would have reduced about one-fifth of its outstanding shares from five years ago. That provides an excellent return to investors in the upcoming years.
China Factor
If there was some weakness in the second quarter results, there were also some positives for Cisco in the same period. At a time when everyone was blaming China for the weak quarterly numbers, the company gained from the region in the second quarter by addressing some of the issues it faced in China hurting its business in the past. For instance, the networking switch maker recorded 40% growth in the order rate in the first quarter. In the same quarter, the order rate jumped 64% driven by video equipment demand. That suggested that it was not a one-off affair, and the company would definitely like to carry on the momentum in the remainder of the period.
Alliance With Ericsson (ST:ERICAs) And Intel
Cisco has aligned with Ericsson and Intel (NASDAQ:O:INTC) to create next generation wireless gear. The three firms would also be pioneering the launch of a 5G router for the deployment in the business, as well as, the residential services. Also, Cisco and Ericsson are working closely to create go-to-market models, as well as, sales force training with a clear focus on six key areas, which are business VPN, fixed cable broadband access, IP core, IP & IT managed services, IP transformation services, and mobile backhaul. The two companies are also working on areas like mobility, networking, and cloud technologies, and have already conducted 200 customer engagements. As a result, they could win more number of customers in the last three-month period.
Aside from these factors, Cisco delivered better than estimated second quarter results and witnessed 2.2% average revenue growth in the last three months compared to the industry fall of 8.5%. The company has delivered TTM Return on Assets and Equity of 9.5% and 17.4% respectively, which were higher than the industry average of 5.6% and 11.5% respectively. Also, its price earnings for the TTM were only 12.9 times compared to the industry average of 89.4 times. Historically, the company enjoyed only a lower valuation. Its dividend yield was healthy at 4% plus.
Conclusion
Cisco is better placed on several counts. It made progress in China and struck alliances with Ericsson and Intel, which should help in the long term. The valuation supports further potential for upside. Those who missed to buy the stock before the announcement of the second quarter results could still acquire the stock and expect to do well.
by Viraj Shah