Cisco layoffs and guidance overshadow strong fundamentals

A dominant market position and aggressive pricing have helped the company gain market share.

By Minyanville.com Oct 1, 2013 2:28PM
Man working in data center © Erik Isakson, Tetra images, Getty ImagesPricing power, data center strength, and higher spending from enterprise customers and government agencies helped Cisco Systems (CSCO) deliver strong financial results for fiscal fourth quarter 2013.
 
Earnings per share of 51 cents surpassed the firm's high-end guidance and analyst expectations of 48 cents. Revenue for the quarter also increased 6.2% from a year earlier, driven by growth in the Americas and EMEA regions of 7% and 12%, respectively.
 
Yet shares have declined approximately 10% from recent highs due to the firm’s weak guidance and decision to lay off almost 5% of its workforce in anticipation of a challenging economic environment.
 
Though Cisco reiterated its annual revenue and margin projections, it lowered revenue growth guidance (2% to 5% vs. long-term 5% to 7% growth) for the upcoming quarter, citing troublesome economic climate particularly in emerging markets like China.
 
China is expected to be a future driver of growth for the networking behemoth, hence, weak prospects in the Chinese market is cause for concern. However, since Cisco generates 80% of its revenue from the U.S. and Europe -- which are performing strongly -- the lackluster near-term performance due to emerging market slowdown is not an extreme concern.
 
Additionally, Cisco's downsizing, which has seen a rather harsh reaction from the Street, should be viewed as a good strategic decision by the firm to reallocate resources for more lucrative product endeavors, and an attempt to ensure that expenses remain in line with revenues if economic environment worsens.
 
The company’s dominant market position as well as its aggressive pricing strategy over the years have helped it gain market share from rivals Juniper Networks (JNPR) and Alcatel-Lucent (ALU). While Cisco has the lion's share of the market in switches (65%) and routing (70%), management has not shied away from entering new market segments.
 
Cisco has pursued an aggressive growth strategy over the last few years, making most of its acquisitions in high-growth segments such as cloud and mobile, which have become a holy grail for almost all tech companies. Some of the recent hallmark acquisitions include Intucell (mobile network management), Ubiquisys (intelligent 3G and LTE small cell technologies), Meraki (cloud-based WiFi systems), SolveDirect (cloud services), and Whiptail (memory systems solutions provider).
 
Our firm's proprietary fundamental metrics give Cisco an Outperform rating. (See chart here.) The company’s qualitative strengths can be seen in several areas such as return on equity (ROE) and financial strength.
  • ROE increased to 17.25% in fiscal fourth quarter 2013 vs.16.1% in fiscal fourth quarter 2012. Additionally, CSCO offers a higher ROE when compared to the peer average of 11.64%.An integrated solution to help you understand your investment's strengths and weaknesses quickly and effectively, the Market IQ Terminal offers investment analysis and portfolio optimization based on proprietary fundamentals, market sentiment, analyst sentiment, and technical parameters.
  • Cisco has an equity to debt ratio of 1.67, which is higher than the industry average of 1.64, indicating strong financial standing relative to its peer group. Additionally, its interest coverage ratio of 19.61 is significantly higher than the industry average of 7.88, which, indicates the firm’s strong ability to meet is short-term debt obligations.
Based on our firm's valuation metrics, Cisco is trading at a discount relative to its peers. Additionally, with a current dividend yield of 2.9%, valuation looks attractive.
 

 
We have maintained a consistently bullish sentiment on Cisco since January 2012, based on chatter pertaining to the company on various social media channels. Looking past the normal volatility in the sentiment chart below, we only see bullish spikes in sentiment -- no predominant negative sentiment dips. Interestingly, Cisco’s stock price has correlated strongly with our sentiment, moving from $19.11 to $24.35, which was a 20% move in nine months (see below for social sentiment chart).
 

 
Post financial crises, the company’s prospects appeared grim. However, Cisco has since gone on to divest its noncore businesses and evolved from a communications partner to a more strategic technology partner. Operationally, the company has done extremely well, as management has focused on generating strong operating cash flows from its core business and expanding to new areas. The company has also successfully kept investor optimism in check, providing conservative guidance on most occasions.
 
Additionally, despite a spending spree over the last three years, management has ensured that the balance sheet is flushed with cash, which paves way for more investments, R&D expenditure, dividends, and share buybacks, and provides a buffer against uncertainty.
 
Overall, Cisco is executing well on its plans and looks well-positioned going forward. The company’s dominant market position as well as aggressive job cuts are likely to help maintain market share from main rivals Juniper and Alcatel-Lucent in an uncertain economic environment, and could help it even further when the concerns subside.

This article was written for Minyanville by Adil Yousuf of Market IQ.

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