Current Price: $57 Price Target: $62 (raising from $58)
Position size: 3.2% TTM Performance: +35%
Key Takeaways:
- Beat expectations on broad based demand growth – driving a top line and EPS beat, aided by gross margins up 60bps.
- Short-term headwind from supply chain delays and chip shortages – this caused FY22 guidance to be lower than expected. Revenue guidance of 5-7% for FY22 assumes a deceleration from current quarter trends of +7.5%-9.5% due to these temporary headwinds which should last for at least 1H22. They’re taking price increases to offset impact to margins.
- Secular drivers ramping – they are benefiting from digital transformation w/ the ramping of associated key technology transitions (Wifi 6, 5G, 400 gig, edge) that are catalysts to companies modernizing their aging network infrastructure. They’ve been investing behind these big market transitions for a long-time, they’re finally starting to come to life and will be long-term growth drivers for their business.
- Mix shift to software and recurring revenue continues – subscription revenue was +15% YoY for the full year, as an increasing number of their products are to be offered this way. They now have one of the largest software businesses in the industry with an annual run rate well over $15B (~$13B of that is subscription).
Additional Highlights:
- Revenue was $13.1 billion, up 8% YoY, coming in at the high end of their guidance range.
- Strongest product order growth in a decade – +31% YoY (up 17% from pre-COVID Q4 levels in FY 2019) driven by strength across all of their end markets
- Analyst Day in September may be a positive catalyst
- Quotes from the call…
- On supply chain issues: “While we are seeing increasing demand for our technology, we are also continuing to manage through the component shortage challenges that nearly every company is experiencing. Our world-class supply chain team as always, is doing an incredible job navigating this complex situation by working with our global suppliers to meet customer demand as quickly as possible. Looking ahead, we expect the supply challenges and cost impacts to continue through at least the first half of our fiscal year and potentially into the second half.”
- On IT budgets: We are seeing IT budgets grow as companies begin to implement their critical future plans and business confidence increases.”
- On broad demand strength: “We saw double-digit growth in every one of our customer segments. This strength is being driven by stronger customer investment in substantial network upgrades to help modernize and secure their environments to support the new way of working.”
- On growth investments: “You will see us continue to invest in our key growth areas in technology shifts like hybrid cloud, hybrid work, 5G, Wi-Fi 6, edge and security”…”given the momentum we’re seeing in our business, we have more conviction than ever that we are investing in the right areas and we’ll continue to extend our competitive advantages and drive growth.”
- Growing mix of recurring revenue should expand their multiple –Software mix is close to 1/3 of revenue w/ >80% of software sold as subscription. That means over 1/4 of total sales is from software subscriptions sales (or ~$14B). Additionally, ~22% of rev is services with much of that from maintenance/support which tend to be recurring. So overall recurring revenue could be ~45% or more (they don’t break it out specifically). They have a growing “as-a-service” portfolio driving the mix shift happening w/in their business which should be supportive of their multiple and their margins. They continue to offer more products this way including Cisco Plus their new network -as-a-service offering.
- Momentum w/ web-scale cloud providers –commentary continues to be very positive. This is an important area of growth for them. They had record performance with over 160% order growth – seeing early traction of their 400-gig solutions, a huge testament to the investments they’ve made. 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. Recently extended their webscale product offering – broadened their Silicon One platform from a routing focused solution to one which addresses the webscale switching market, offering the highest performance, programmable routing and switching silicon on the market.
- During Q4, closed five acquisitions, Kenna Security, Socio Labs, Slido, Sedona Systems and Involvio – consistent w/ strategy of complementing R&D with targeted M&A to strengthen their market position growth areas.
- Valuation: trading at a 6.5% FCF yield on fiscal 2022, 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. Fundamentals continue to be supported by business transformation/digitization trends (which are accelerating) at a reasonable valuation while much else in tech has seen substantial multiple expansion. Additionally, their valuation is supported by a 2.6% dividend yield which they easily cover. They grew their dividend for the 10th consecutive year and are committed to returning 50% of FCF annually to shareholder through dividends and buybacks. They have ~$13B in net cash on their balance sheet, or >5% 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]