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Cisco Outlook Takes Trade War Hit

Sejuti Banerjea

Cisco CSCO reported revenue and earnings that barely exceeded the Zacks Consensus Estimates by 1.3% and 0.4%, respectively. But investors are generally more concerned about orders because they are indicative of future performance. That’s where Cisco under-delivered.

A quick look at the earnings call slides clearly shows that the softness is attributable to the APJC (Asia/Pac basically) segment with service provider and enterprise customers being the major pressure.

Service provider issues are nothing new. These customers are cash constrained. From a geographic viewpoint, however, it’s clear that APJC played spoil-sport, with difficult comps in India and continued weakness in China. Segment orders were down 21%.

The 2% decline in enterprise orders was the other negative, with the commentary around it being more disturbing. It appears that the Chinese government isn’t inviting bids from Cisco any longer and management says it’s related to the trade war. Chinese actions accounted for a point, or half of the decline in enterprise orders.

But that isn’t true of the technology sector as a whole. The sector has huge (and growing) exposure to China by virtue of its being the place where the largest chunk of the world’s population is located and because it’s still in the “developing” country category. To get unceremoniously kicked out of that growth just can’t be good or desirable.

Don’t Bet Against Cisco Though

China thankfully accounts for just 3% of its business and Asia/Pac generates lower margins for the company. So the geographic mix was positive for the gross margin last quarter. The continued mix shift favoring software was also positive.

Second, the transition to a subscription model is largely complete, with 70% of all software revenue now coming through it. The company is including software (and security) in a growing number of services, which is helping subscription revenue. The recurring revenue model lends stability to a business that was earlier harnessed to high-end hardware.

As far as product categories are concerned, infrastructure of course remains the largest segment by far, with switching strength at on-premise and data center customers and routing hurt by service provider weakness. The applications business was up double-digits across segments.

And finally, the stock has taken enough of a beating of late, so its valuation currently looks attractive, both with respect to the S&P 500 and the technology sector. Moreover, it’s also trading close to its 52-week low.

Recommendations

Cisco shares carry a Zacks Rank #3 (Hold). Better picks include Axalta Coating Systems Ltd. AXTA,  Ennis, Inc. EBF, Integer Holdings Corp. ITGR, Pilgrim's Pride Corp. PPC, since they have a Zacks Rank #1 (Strong Buy). Or, see the the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

 

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