Cisco matures, stock is ready to join it – MarketWatch
GRAND BLANC, Mich. (MarketWatch) — Much has been made of the Nasdaq Composite Index’s recent surge to the 5,000-point level, a milestone not achieved since the height of the so-called “dot-com” bubble in March 2000. At the time, venerable software titan Microsoft was the most valuable company in the composite, but its status as number one was briefly surpassed in late March 2000 by Cisco Systems, the leading supplier of data networking equipment and software. Cisco’s core business of routers, switches, access equipment and network-management software was widely perceived as the backbone on which the Internet operates, and thus worthy of all of the exuberance investors placed in it at the time.
Of course, any investor around since 2000 knows what happened next. The dot-com bubble burst, and by October 2001, Cisco’s CSCO, -1.40% market cap was knocked down a staggering 85% below its peak — the single most meaningful contributor to the overall decline in the Nasdaq during this period. Since the trough, Cisco stock has fallen in and out of favor with Wall Street, outperforming nicely during a 2006-2007 stretch in which equities were broadly rallying, then weakening during the subsequent 2008-2009 market downturn.
In 2011, the company embarked on a series of initiatives designed to enhance shareholder value and improve its financial performance, beginning with the declaration of its first ever quarterly dividend. Since that first payout of $0.06 four years ago the quarterly dividend has grown consistently to the current $0.21 per share.
Later in 2011, following a disappointing earnings report, CEO John Chambers announced an effort to eliminate $1 billion in costs, including a workforce reduction of 6,500. Long seen as a company primarily focused on growth, this 2011 announcement represented a sea change in how Wall Street viewed the company. Cisco was now a more mature firm seeking to stabilize and enhance its bottom-line earnings. As it played out, this restructuring proved difficult, and the stock performed poorly relative to the market through the three-year period from 2011-2013.
Recently, however, a leaner and better-structured Cisco has rewarded patient investors, with shares returning nearly 40% in the 12 months through February 2015. Particularly encouraging was the recent investor call featuring notably optimistic comments from Mr. Chambers, a CEO generally seen as conservative on guidance.
In the most recent quarter, Cisco beat earnings-per-share expectations for the sixth straight quarter, with $0.53 per share earnings compared to expectations of $0.51, and $0.47 a year ago. It reported revenue of $11.9 billion in the quarter, beating expectations and up 7% from a year ago, the firm’s highest annual growth rate in three years.
These results are even more notable when viewing the comparatively weak top-line growth reported in the same period by peers such as Juniper Networks JNPR, +0.21% (13.5% lower sales), Alcatel Lucent ALALF, +15.54% (2.2% lower), and Hewlett-Packard HPQ, -0.18% (2.5% lower). In other words, if Cisco is already the number-one firm, and it is growing, while the competition is declining, it means that Cisco is (quoting Mr. Chambers from the conference call) “pulling away from [its] competitors” and it “could not be better positioned in the market.”
Moreover, Cisco will benefit from mergers and acquisitions that reduce the number of competitors and enable more stable pricing and margins on its core products. For example, the recent news that rival HP will acquire Aruba Networks — the number-two player in the enterprise Wi-Fi market — will ultimately help Cisco, who already boasts a dominant 46.8% share of this market (currently, Aruba is 11.8% of the market and HP is 4.5%).
Whether this stock moves meaningfully higher may well depend on its ability to diversify into areas outside of routers and switches. In the intensely competitive cloud-infrastructure equipment market, new data from the Synergy Research group shows that the race for market share may be coming down to a “two horse race” between number-one Cisco (currently at 15%) and number-two HP (13%), with stagnant or falling market shares for Microsoft MSFT, -0.12% IBM IBM, -0.64% and Dell.
Chambers’ vision is for Cisco to become the leader in all areas of IT infrastructure. In addition, the firm is discussing its long-range plan to position itself for the “Internet of Everything,” the basic idea that more and more physical objects will become digitized electronically in the future and be of greater service when connected to each other. According to its calculations, this opportunity may represent a $14.4 trillion (that’s trillion with a “t”) market over the next decade. Given Cisco’s formidable market position in related areas, it’s clear why the company is so optimistic about current prospects.
As a value play, Cisco is inexpensive by virtually any measure, trading at discounts to its 10-year average multiples to book value, sales, earnings, and cash flow. Cisco also looks cheap compared to other tech companies, with an enterprise value to EBITDA ratio of 9.3 times, compared to a tech industry average within the S&P 500 of 16.3 times. On a price-to-free-cash-flow basis, Cisco currently measures a 13.8 times multiple compared to a significantly higher multiple for the S&P 500 technology group of 21.2 times. Its recent dividend increase boosts the dividend yield to 2.8%.
Once a poster child for the “tech wreck” of 2000-2001, Cisco is showing signs of being more mature, leaner, and better positioned to be a global tech titan. The shares have moved higher in response to the recent good news, but given the opportunities for growth and modest valuations, Cisco shares continue to merit our enthusiastic buy recommendation.
David Kudla is CEO and Chief Investment Strategist of Mainstay Capital Management, a fee-only, independent, Registered Investment Advisor. More information about his firm can be found at www.mainstaycapital.com. Follow him on Twitter@David_Kudla.
Disclosure: Clients and employees of Mainstay Capital Management may hold the securities mentioned in this article in their investment portfolios. The securities mentioned may not be suitable for some investors, based on their tolerance for risk or their investment time horizon.
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Cisco matures, stock is ready to join it – MarketWatch
