Current Price: $41 Price Target: $58
Position size: 2.8% TTM Performance: -9%
Key Takeaways:
· Top line and EPS beat with better-than-expected guidance.
· Upbeat guidance suggests macro environment showing signs of improvement. Aging network infrastructure needs to be upgraded. Growing use of new technologies and increased data demand places increased importance on this.
· Mix shift to software and recurring revenue should continue as an increasing number of their products are to be offered this way.
· Cost cutting to help preserve earnings power – $1B in annual cost reductions to be implemented over next few quarters.
· CEO Chuck Robbins said…“Cisco is off to a solid start in fiscal 2021 and we are encouraged by the signs of improvement in our business as we continue to navigate the pandemic and other macro uncertainties.”
Additional Highlights:
· Overall, business trends are weak but improving, they are lapping easy compares this coming year amidst some aggressive cost-cutting initiatives, transition to software/subscription continues, valuation is inexpensive, and they have a high dividend yield (3.5%) that’s easily covered.
· Q1 sales -9% YoY and EPS -10%. Q2 revenue guided to 0% to -2%. Street was expecting -3.5%.
· New CFO announced – Scott Heron (was Autodesk CFO) , he will replace Kelly Kramer whose retirement was announced last quarter. He has a background in software and helped to lead Autodesk’s successful business model transformation from perpetual licenses to subscription software.
· Improved demand commentary relative to last quarter…
· By product – Soft demand w/ campus/DC switching, routing, servers, and WLAN still offsetting positive Webex, security, Cat9K, WiFi-6 trends, but order patterns are improving.· By end market – Positively, order patterns in public sector were solid while headwinds w/ commercial/enterprise are set to subside. Saw a pretty significant improvement in commercial orders -they were minus 23% last quarter in the midst of a “SMB meltdown,” that improved to -8% this quarter.
· As I mentioned last quarter, Gartner expects global IT spending to decline -7% in 2020. Within this there are pockets of strength, like public cloud spending as companies shift IT budgets to areas of immediate need. For much of Cisco’s products the needs are less immediate, but the LT drivers still exist. Management talked about this dynamic on the call. “We had customers who are super-focused on getting their employees working from home productively and getting their security set up. I think everyone raced to do that and then I think they took a pause, which is what we felt in our last quarter in orders. And then I think they re-prioritized what they were going to be spending money on and I think we started seeing some of that come back and it’s sort of exactly what I expected, but we needed to see it and we’ll see if it continues. But we’re all dealing with the same macro environment.”
· Positive commentary points to continued software/services mix shift and strength in new products –This includes strong demand for their Catalyst 9000, security, WebEx and other SaaS-based solutions. Software mix is close to 1/3 of revenue, w/ 78% of software sold as subscription. That means almost 1/4 of total sales is from software subscriptions sales (or close to $12B). Additionally, 27% of rev is services with much of that from maintenance/support which tend to be recurring. So overall recurring revenue could be 40% or more (they don’t break it out specifically). So while top line growth has been weak, the mix shift happening w/in their business should be supportive of their multiple and their margins. They intend to grow this mix over time.
· Momentum w/ web-scale cloud providers – the positive commentary from last couple quarters continued. This is an end market where they lost share to Arista in the past, but their positioning is improving w/ new products announced last Dec. That being said, this is still early stages – mgmt. indicated it may take a year or two for this to be a meaningful top line contributor.
· Valuation: trading at almost an 8% FCF yield on fiscal 2021, which ends in July. This is well below S&P average of <4%, for a strong balance sheet, high FCF generative business w/ a growing mix of software and recurring revenue. Despite macro headwinds, fundamentals continue to be supported by business transformation/digitization trends at a reasonable valuation while much else in tech has seen substantial multiple expansion. Additionally, their valuation is supported by a 3.5% dividend yield which they easily cover. They have ~$15B in net cash on their balance sheet, or almost 9% of their market cap.
Sarah Kanwal
Equity Analyst, Director
Direct: 617.226.0022
Fax: 617.523.8118
Crestwood Advisors
One Liberty Square, Suite 500
Boston, MA 02109
$CSCO.US
[category earnings ]
[tag CSCO]