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Cisco Systems: Slow Growth, but Opportunities Ahead

·3 min read

Cisco Systems Inc. (NASDAQ:CSCO) is the largest provider of hardware and software solutions in the networking industry. Hardware products comprise switches, routers, data center and wireless applications. Security solutions is also an important area for the company and includes firewall and other software-defined products. The company also offers collaboration products comprising unified communications, Cisco TelePresence and conferencing, as well as the internet of things and analytics software.


The company is also known as one of the most prominent bubble stocks of the 1999 dot-com boon. After reaching outrageously high valuations in 1999, the stock has still not recovered from the highs it hit in March 2000. It is a painful lesson that investors should take to heart after the crazy stock valuations we saw in 2021, and still see today in some areas.

Founded in 1984, Cisco is expected to generate over $51 billion in revenue this year and currently has a $179 billion market capitalization.

The company is still dominated by hardware products and has been trying to transfer to software and subscriptions for quite some time now. Ciscos transition to software and subscription is taking longer than expected and has created growth problems as 60% of its revenue is still generated from hardware.

Financial review

Cisco has struggled with growth recently. For the third fiscal quarter ending April 30, revenue was essentially flat over the prior-year period. Net income increased 6% to $3 billion and earnings per share increased 7% to 73 cents.

Cisco Systems: Slow Growth, but Opportunities Ahead
Cisco Systems: Slow Growth, but Opportunities Ahead

Growth in terms of product lines was mixed. Secure, Agile Networks increased 4%, Internet for the Future was up 6%, End-to-End Security rose 7%, Optimized Application Experiences grew 8% and Collaboration was down 7%.

The company has typically maintained a very safe balance sheet and at the end of the third quarter, cash and short-term investments totaled $20.1 billion while total debt was $9.4 billion. Backlog, or Remaining Performance Obligations (RPO), increased 7% to $30.2 billion, of which roughly half will be recognized over the next 12 months.

In the third quarter, the company returned $1.8 billion to stockholders through share buybacks and dividends. Cash dividends paid totaled $1.6 billion and stock repurchases totaled $252 million.

Valuation

The company has recently given annual guidance, which calls for 2% to 3% revenue growth and earnings per share in the range of $3.29 to $3.37. Consensus earnings estimates call for $3.35 for this fiscal year (ending July 2022) and $3.52 for the following year. However, these are non-GAAP estimates due to high levels of stock compensation paid out to the company. GAAP estimates are roughly $2.81 for this fiscal year and $3 for the following year.

I believe stock compensation is a real expense and that GAAP estimates should be used. On that basis, Cisco is selling for 15 times this year's estimates and 14 times the following year's estimates.

The stock is selling near 52-week lows, which has created a high dividend yield situation. The company pays an annualized dividend of $1.52, which equates to a 3.53% dividend yield currently.

Guru trades

Gurus who have purchased Cisco stock recently include Charles Brandes (Trades, Portfolio) and Richard Pzena (Trades, Portfolio). Gurus who have sold or reduced their positions include the Tweedy Browne (Trades, Portfolio) International Value Fund and the Yacktman Fund (Trades, Portfolio).

Conclusion

Cisco appears to be undervalued if it can maintain some level of sustained earnings growth. The company can also take advantage of the shift to a hybrid work environment with its popular Webex line of products.

The shift to a higher growth, recurring software and services model is taking longer than expected, but the transition should eventually occur in a material way. Software is now approximately 40% of total revenue.

This article first appeared on GuruFocus.