Current Price: $46 Price Target: $58
Position size: 2.8% TTM Performance: -1%
Key Takeaways:
· Top line and EPS beat with better-than-expected revenue guidance.
· Macro environment improving but still seeing uneven trends in enterprise – saw improvement in all major customer segments, but weakness persists w/ large customers in hard hit industries like retail and hospitality, while other sectors are improving. Saw continued improvement with commercial customers (SMBs). Public customers (i.e. gov) is an area of strength. And Service Providers (telecom/cloud) is improving driven by share gains with hyperscale cloud providers.
- Secular drivers still in place – 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 continues as an increasing number of their products are to be offered this way.
· Cost cutting to aid earnings power – $1B in annual cost reductions to be implemented over next few quarters.
· CEO Chuck Robbins said…“we are seeing encouraging signs of strength across our business as the recovery takes shape, with all customer segments showing improvement in year-over-year growth rates”…” I am confident in our ability to capture the long-term opportunities ahead, in areas such as cloud, 400 gig, 5G, security, hybrid work and next-generation applications.”
Additional Highlights:
· Overall, business trends are improving and 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 (3.2%) that’s easily covered.
- Q3 revenue guided to 3.5%-5% w/ street expecting ~2.8%.
- Strong gross margins – GM was 70%. The highest since 2006.
- Total product revenue was $8.6 billion, down 1% – product revenue (>70% of total rev; rest is services) is comprised of Applications (flat), Security (+10%) and Infrastructure Platforms (down 3%). Infrastructure platforms is >50% of revenue and is the product area most impacted by the COVID environment.
- Continue to see signs of gradual improvement led by order growth in Commercial, Public Sector and Service Provider businesses, which together account for nearly three quarters of product orders. The Enterprise market remains soft, driven by some elongated sales cycles and a continued pause in spending among some customers brought on by the pandemic.
- Acacia acquisition should close next quarter. Gives them optical technology that should help their competitive position in 400G upgrades essential to meet bandwidth requirements and high-speed connectivity.
· Improved demand commentary relative to last quarter…
- Order trends have broadly improved QoQ across every region and customer segment.
- From a product revenue perspective – saw strength in Catalyst 9K, data center switching, security, wireless and Webex (600 million quarterly average users) portfolios. Cat 9K momentum continues, up double-digits, aiding improvement in campus switching. Security revenue grew +10% Y/Y driven by good momentum in its cloud offerings, Duo and Umbrella.
- “Looking ahead, we are cautiously optimistic, as recent surveys of IT spending indicate year-over-year IT budget growth for calendar 2021 and Cisco remains well-positioned among CIOs top forward-looking spending priorities, including network infrastructure, cyber-security software, as well as cloud migration and cloud infrastructure.”
· 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 ($3.6B in Q2), w/ 76% of software sold as subscription. That means almost 1/4 of total sales is from software subscriptions sales (or ~$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 few quarters continued. They disclosed that Webscale was 25% of Service Provider orders (larger than expected) and order growth accelerated, up >100% in Q2. This is an end market where they lost share to Arista in the past, but their positioning is improving w/ new products launched last year. 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. Could see performance vary quarter to quarter, due to the timing of large deals, but they are “incredibly confident” around their prospects in this area.
· Valuation: trading at >7% 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 (~30% FCF margins) 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 3.2% dividend yield which they easily cover. They have ~$16B in net cash on their balance sheet, or almost 8% 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]