- Poor Q2-2016 guidance caused Cisco stock to sell off. However this company is still producing positive growth both on the top and bottom line.
- The company's switches division performed very well despite heightened competition from white box manufacturers in this area.
- Cisco is continuing to invest heavily into the Internet of Things (IoT). The company's service division is growing strongly so expect mass acquisitions in order to gain market share.
Cisco (NASDAQ:CSCO) stock dropped over 5% on 13th of November, even though the company exceeded analysts expectations, both on the top line ($12.68 billion reported compared to $12.65 expected ) and the bottom line (EPS of $0.59 compared to the $0.56 expected). Earnings beat usually move stocks, but since Cisco has beaten estimates in every quarter since 2011, there was definitely a sense of inevitably that the company would do it again in Q1-2016. The main reasons for the sell-off after the announcement was the earnings guidance the company announced for the next quarter which is down a couple of cents from Q1-2016.
Furthermore the street had projected next quarter's revenue to grow at 5%, but Cisco is only guiding between 0 to 2% growth on a rolling year basis. Nevertheless I just believe the numbers still stack up in favor of this company despite the sluggish growth outlook. The fundamentals and balance sheet are extremely strong. I would advise investors to use this pull-back as an opportunity to start scaling into this stock. Let's discuss...
Firstly investors shouldn't forget that this stock is still trading off its 2015 highs despite having growth, despite continually growing its net income and revenues. What has wall street worried about Cisco currently are its growth rates and its stellar profit margins which have been declining sequentially since 2005 (see chart).
However gross margins rose in the first quarter of 2016 to over 63%, which has to be bullish for the company considering that market was pricing in declining margins. Margins had been slipping because the company has been facing more competition in its switching division. However new products in this area (Nexus 9000 switches) seem to be gaining traction as switching rose 5% in Q1. Furthermore we know from history that product upgrades (which happen every few years) usually give the company a multi-quarter tailwind so I don't expect "switching" growth rates to slow down any time soon.
What I like about Cisco is that the company is still growing its top and bottom line even though it derives a significant proportion of its sales abroad. The strong dollar may be slowing down its growth curves but not enough to stop the company posting positive growth. There is opportunity here for investors as the company is growing its profits and top line in the face of a strong dollar and the valuation is getting cheaper.
Other US multi national companies for example have been reporting "organic growth or currency amended " earnings (which are really negative earnings) and the respective stock sometimes rallies. Cisco with a present p/e ratio of 15, a 40% 3 year dividend growth rate and $35 billion of net cash on its balance sheet will attract value investors who will start to step in if Cisco stock falls much further from here.
Bearish investors will undoubtedly point to the company's routing division which was down 8% in Q1-2016 compared to the same quarter of twelve months prior. This division is a big part of the company's overall business but investors should look at the company as a whole instead of pin-pointing areas that are experiencing negative growth. Why? Because this company is transitioning slowly into a software and service company as this is where the company feels the real growth will be in the future. I believe the transition is being executed very well as demonstrated by the higher margins the company reported this quarter.
So to sum up, I would advise investors to begin to scale into Cisco stock because I feel the headwinds the company is experiencing will be temporary. Firstly both the top and bottom line continue to grow despite dollar strength. Secondly the transition into software and services (where more recurring income will be) is going very well with margins significantly higher than what analysts had expected this quarter. Thirdly we had some moving parts also in Q1-2016 when the company sold its set-top box business which illustrated again the company's move into software and cloud services.
We can see this ongoing transition in acquisitions such as Portcullis and Par-stream that will close in the second fiscal quarter of 2016. The Internet of things (IoT) initiative is definitely where the company wants to focus on. I have written before that multiple acquisitions may cause integration risk down the road. Watch its service segment growth rates along with margins. If these stay elevated, the afore mentioned risk will definitely be decreased going forward.