- Consensus Price target of $31+ per share is still well above where the Cisco stock is currently trading.
- Software, services and security products should keep profits elevated. Routers and switch gear margins are falling but they still spin off huge cash flow.
- $10 billion will be invested into China in the next few years. Cisco wants to return to growth here through the use of joint-ventures.
- Intangibles and good-will subsets on its balance sheet are quite high at $27 billion. Cisco's high level of acquisitions definitely pose an integration risk if they increase in number.
Cisco earnings for the current fiscal quarter will be out on the 12th of November and analysts are bullish on the numbers. EPS expectations are $0.56 per share on projected revenues of $12.65 billion. These numbers are ahead of the same quarter in 2014 with EPS coming in at $0.54 on revenues of $12.24 billion. Cisco (NASDAQ:CSCO) stock has recovered completely from its August lows.
Cisco is a prefect example of a stock that the market looks unfavorably on because of recent slow growth rates despite having one of the best balance sheets in the S&P500. Why? Well its revenue metric over the past few years is basically flat (see chart) because its switch gear and router divisions (where it derives most of its income) have been slowing down meaningfully especially in recent quarters. This consequently has adversely affected margin levels even though the company still produces stellar margins on its products.
The company is doing everything it can to return to better growth levels but until it does, wall street will continue to look unfavorably on Cisco stock. However this company has an extremely strong balance sheet considering the company has over $60 billion in investments and cash. Furthermore Cisco generates huge amounts of free cash flow every year which illustrate that its share buybacks and increasing dividends are definitely not at risk. Its return on equity of 15% confirms its strong financials and I just feel there is not very much downside potential in this stock. Let's go through this article and discuss where the company is going while also outline some risks that company may face in the near term.
A Company In Transition
Although Cisco came out with a new brand of switches recently called "Nexus 9000", wall-street and investors alike feel that the company will never be able to return to the sizable market share it once had in this area. Why? Because white-box manufactures are both cheaper and offer customized options to their clients.
However Cisco is transitioning from this division into more software and services. Why? Well the company see's far better potential here especially in terms of recurring income. Its service segment for example is growing at almost 4% per quarter which definitely illustrates strong future growth. This segment along with the company's continuing elevated spend on the "Internet of Everything" initiative should definitely increase revenues over time due to more product sold and more recurring income through servicing.
Internet Of Everything
Cisco see's big growth potential in its "Internet of Everything" program and its recent acquisitions confirm the potential the company sees. However there are many companies investing into this area at the moment, such as Intel (NASDAQ:INTC) and IBM (NYSE:IBM). Where is the risk here for Cisco here in this high growth potential market? Well it has to be its high level of acquisitions which investors still don't know for sure if they will work out.
Look at the table below and observe the intangibles and good will numbers. These come in at almost $27 billion despite reporting assets of $113 billion. I just think its quite high and illustrates the risk that company's take when they perform a high level of acquisitions. Only time will tell if they will pay off.
In terms of future growth, it will be interesting to see if the company can regain lost market share in China over the next few years. Cisco contributed enormously to the roll-out of the Internet in China over the past few decades which made the market extremely profitable for the company but ever since 2013, sales have been slipping meaningfully (see Chinese estimation Chart from Dell’Oro Group below).
Market Share Slump In China
The sales slump is primarily due to Edward Snowden's comments in 2013 ( Former US national security contractor) when he stated that the American government utilized US tech firms to spy on China. This then led to the Chinese government and state owned companies to use more products and services of local Chinese companies and not foreign enterprises such as Cisco. Cisco's response has been to partner with Chinese companies (where its Chinese counterpart has a bigger stake) in an attempt to grow its Chinese sales once more.
To give you an indication of how much Cisco's router sales have dropped in China, consider the following. More than 10 years ago, Cisco had half of the market share in the country (router division) but this had dropped to currently under 11% as local companies such as Huawei have drastically eaten into Cisco's market share. However Cisco (probably through the use of joint-ventures) has not given up investing in China and announced recently that it will invest $10 billion there over the next few years in an attempt to return to growth levels of decades past, despite Chinese revenues currently only being about 3% of total turnover. This may never happen but any uplift in this huge market should be beneficial to Cisco's stock long term.
To sum up, I expect Cisco to match if not beat estimates when it announces its first quarter 2016 fiscal earnings on November 12th. The company has strong momentum behind it as we witnessed in its Q4 2015 earnings and I see no reason why this momentum should slow. The company is correctly transitioning to software and services as that seems to be where future potential and profitability lies.
Furthermore and as discussed earlier, this company's balance sheet is very strong which is why shareholders should continue to get rewarded through buybacks and increasing dividends even if we don't see meaningful movement in the share price. Watch China. If revenues can start growing there once more (like India), then I would expect investors would begin to take more interest i this stock which would move it higher once more.