For investors in Cisco Systems, Inc. (NASDAQ:CSCO) it has been a rather dull couple of years. CSCO stock nearly doubled between 2012 and late 2014, but since then, the stock has traded quietly in a range between $25 and $30 per share.
Even a new CEO and a bunch of new acquisitions haven’t done much to spark interest in CSCO stock lately.
However, where there is investor neglect, often there is also opportunity. Cisco offers a healthy dividend yield, trades at a much cheaper price-to-earnings ratio than the S&P 500 as a whole, and business is humming along so far in 2016.
Are shares a buy here ahead of a potential move above the $30 mark?
CSCO Stock Pros
Uniquely Safe Technology Company: Let’s be clear from the outset. Cisco is not a great pick if you want the electrifying sort of growth that comes from younger technology companies. CSCO stock, by contrast, represents a much safer pick. If anything, you can think of Cisco as a tech utility company; it provides distinctly unglamorous but essential components that underpin the internet and thus the modern economy.
Despite turbulent economic swings, Cisco has grown revenues 10 out of the past 13 years. Earnings consistently rise, and due to the company’s relatively stable offering of products and aggressive capital return policies for shareholders, CSCO stock is about as safe a harbor as you can find among tech stocks. While the company is making moves toward cloud security and the internet of things, the company’s network hardware retains a strong moat. The company has plenty of time to figure out the next big growth market as hardware continues to throw off geysers of free cash flow.
Fortress Balance Sheet: Cisco has a fantastic balance sheet. Despite the company’s strong capital return policy via a generous yield and share buyback program, it still has been able to accumulate a large surplus of cash and marketable securities as well. The company now has $63 billion in cash and marketable securities. Making this even more remarkable, the company has grown that warchest every single year without fail since 2003.
Against that $63 billion in cash and short-term investments, the company has just $56 billion in total liabilities and a mere $24 billion in long-term debt. It’s extremely rare for companies to carry more cash than their total outstanding liabilities. Cisco is well-positioned to make future acquisitions, invest capital internally or continue increasing the dividend regardless of short-term industry or economic cycles. The company already yields 3.6%, and that dividend has been raised aggressively; the hike this year was 20 cents annually, boosting the yield by more than half a percentage point.
Cloud Security: Given the necessity of routing equipment for internet functionality, Cisco’s core product lines have quite a few years of good life ahead of them. Eventually though, as has happened elsewhere, the money will move from hardware to software. Cisco is preparing for this transition.
Since new CEO Charles Robbins took the reins, Cisco has made eight acquisitions, seven of which have been focused on the cloud. With Cloudlock, Lancope, and OpenDNS alone, Cisco has invested more than a billion dollars into cloud security, an area where there are few complete solutions for clients currently available and substantial market opportunity remains.
CSCO Stock Cons
Not A Lot of Growth: Despite rapid growth in the cloud area, where revenues grew 50% year over year, Cisco is not showing a whole lot of top-line growth. Network hardware equipment is a mature space that offers great cash flow but little business upside. Analyst consensus estimates show less than 3% expected revenue growth for 2017 versus this year.
Not surprisingly, earnings aren’t expected to move much either. 2016 full-year earnings are projected at $2.33, with a 10-cent-per-share bump to $2.43 for 2017. The stock is cheap now on a P/E ratio and price-to-free-cash-flow basis, but make no mistake — in the intermediate term, the 3.7% dividend yield will be a significant portion of your overall return, as the stock is unlikely to get much boost from rising sales or earnings.
Mr. Robbins’ Strategy Could Backfire: After replacing the iconic John Chambers, who ran Cisco for 20 years, new CEO Charles Robbins has a different plan for the company. Instead of mainly just selling hardware, where it is dominant — Cisco products are currently involved in 80% of internet traffic — Robbins wants to sell hardware with integrated software. As he explains it, customers don’t want to have to assemble the networks themselves, they want a company like Cisco to sell an integrated solution to their IT needs.
This may well be true, or it may not. Mr. Chambers was an excellent executive, and his strategy produced excellent profits and cash flow for Cisco. Mr. Robbins’ new approach is exciting, but it represents a major departure from a business plan with 20 years of proven success. Let’s watch how these new cloud acquisitions pan out to see if the new CEO’s vision of the future is unfolding.
Pricing Pressure: A quick look at Cisco’s results show generally rising net and operating profit margins. The quick take would be that the company is successfully holding the line of pricing. However, it turns out these gains have come from cutting costs and improved productivity, and both of those levers can only be pushed so far. The company faces more competition, particularly in its services and recurring subscription products segments.
In a conference call earlier this year, Cisco’s CFO stated that: “So as you know, we continually have some price erosion, and we use price as a lever to drive selling.” Despite the company’s dominate market share and strong brand, it is still having to fend off competitors by cutting prices. All that is to say, the recent rise in margins could reverse in coming quarters, and combined with the slow growth in top-line revenues, it indicates there will be trouble growing earnings at a rate faster than a couple percent per year.
Verdict on Cisco
Cisco is a great company, and it is selling at a fair price. CSCO stock has long struggled to break the $30 level. If and when resistance there gives way, the stock could have some near-term upside as it breaks out.
That said, the case for Cisco is mostly as a strong dividend payer at this point, as there isn’t a lot of near-term upside for earnings or revenues and at $28, CSCO stock isn’t exceedingly cheap.
I’m a Cisco shareholder, but I’d wait for another dip before adding to my position.
At the time of this writing, Ian Bezek owned CSCO stock. You can reach him on Twitter at @irbezek.
