US systems specialist Cisco (US: CSCO) - which designs and manufactures network equipment, set-top boxes, and security software - has had a torrid time recently. But as comparisons with past periods get easier, the benefit of new products kick in and the group continues to return piles of cash, the shares could start moving ahead off their current lowly rating.
- • Yield and share buy-backs
- • Good growth in wireless, security and cloud products
- • Trades at a discount to historical multiples and peers
- • Exposed to global data centre, systems and network markets
- • Weak product sales and shrinking margins
- • Sales forecast downgrades
Fewer emerging markets orders and fierce domestic competition prompted Cisco to lower its long-term revenue forecasts in December, from growth of 5 to 7 per cent over the next few years, to between 3 and 6 per cent. It also said that sales could slump 6 to 8 per cent year on year in the current quarter, which ends in May. However, lowering market expectations should give the tech giant more freedom to focus on what is really important: reshaping its struggling business and dispersing the cloud of investor uncertainty over its prospects.
Second-quarter results announced in February clearly reflected the problems the group currently faces. Service provider video sales fell 22 per cent while revenues from the sale of its core switches and routers, which account for 46 per cent of the total, dropped by double-digits. Moreover, its product gross margins fell 320 basis points to 58.8 per cent - the lowest level in 10 years. This helped inflame fears about the competitive pricing pressures faced by the group.
But Cisco has been gaining ground elsewhere, reporting order growth in areas such as wireless, security and cloud products. Indeed, management says the group's order backlog is the largest it's been in 10 years. And while cloud computing is a trend that is harming Cisco on one hand, it is also an opportunity it can't resist, with plans to spend $1bn on developing its own cloud services over the next two years.
The group should also benefit from new products, such as its Nexus 9000 series of network switches, where orders should now start coming in following a period of customer evaluation. It has also been shifting towards offering more software and services, which command higher margins. Services revenues in the second quarter represent 24 per cent of the total. More broadly, Cisco is well-placed to profit from the 'Internet of Everything' as the flood of devices for people's homes, offices and cars will need to be connected and secure.
Emerging markets, which have weighed heavily on recent trading, also show signs of stabilising. Sales trends have improved with last quarter's emerging markets' sales decline of 3 per cent a substantial improvement from the preceding quarter's 12 per cent slump.
| CISCO (US: CSCO) | ||||
|---|---|---|---|---|
| ORD PRICE: | $21.69 | MARKET VALUE: | $112bn | |
| TOUCH: | $21.69-$21.70 | 12-MONTH HIGH: | $26.49 | LOW: $19.98 |
| HISTORIC DIVIDEND YIELD: | 2.9% | FORWARD PE RATIO: | 11 | |
| NET ASSET VALUE: | $10.89 | NET CASH: | $32bn | |
| Year to 27 Jul | Turnover ($bn) | Pre-tax profit ($bn)** | Earnings per share ($)** | Dividend per share (¢) |
|---|---|---|---|---|
| 2011 | 43.2 | 11.5 | 1.6 | 12 |
| 2012 | 46.1 | 12.8 | 1.7 | 28 |
| 2013 | 48.6 | 13.7 | 2.0 | 62 |
| 2014** | 46.3 | 13.3 | 2.0 | ** |
| 2015** | 47.0 | 13.6 | 2.1 | ** |
| % change | +1 | +2 | +5 | - |
*Includes intangible assets of $27.8bn, or 539¢ a share **JPMorgan forecasts, adjusted PTP and EPS figures, no dividend forecasts available £1=$1.65 | ||||
Cisco is also dealing with the headwinds it faces by becoming leaner. It plans to cut about 5 per cent of its workforce in the coming months, or 4,000 jobs, and last quarter its operating expenses fell 9 per cent on the year. And while most of the group's cash is stuck offshore pending resolution over tax issues, cash returns are nevertheless an important factor in the investment case. The group returned $4bn through buy-backs last quarter, with a further $12.1bn buy-back authority remaining. Some 'Cisco-watchers' believe about half of the group's current market value could be returned over the next four years.
Share buy-backs should help underpin EPS and, trading at just 11 times JPMorgan's forward earnings estimates, the shares are a third below their historical average and well below Cisco's peer average of 17, based on S&P Capital IQ data. Strip out cash, and its multiple is closer to eight times.
