Cisco Systems, Inc. (NASDAQ:CSCO) has just delivered second-quarter FY17 earnings that beat expectations on Wall Street, but once again proved that Cisco stock will not be returning to growth any time soon.
Cisco reported fourth-quarter revenue of $11.6 billion, $50 million above Wall Street consensus estimate, but -1.7% year-over-year. That marked the fifth straight quarter that the company has posted falling revenue.
Sadly, things appears set to remain that way for at least the next few quarters. After all, Cisco guided to revenue growth of -2% to breakeven for the current quarter, and sees non-GAAP per-share earnings coming in at 57 cents 59 cents, in line with Wall Street’s consensus of 58 cents.
Oddly enough, Cisco stock has tucked on gains of 6% since the earnings call, reversing the selloff that happened immediately after the results. Cisco stock is now up a solid 13.3% year-to-date. So why, pray, are investors celebrating Cisco’s revenue tailspin?
Business Model Transition for Cisco Stock
CSCO is stuck in the throes of a serious business model transition. Since its early days, the company has been in the business of selling switches and routers that move data around the internet. That’s still true in a big way since the company still derives more than 40% of its revenue from this networking business.
But with more and more companies relying on rented computing services from the likes of Microsoft Corporation (NASDAQ:MSFT) and Amazon.com, Inc. (NASDAQ:AMZN), they are buying less and less of Cisco’s hardware for their data centers.
Even worse is the fact that when they do buy, they are upgrading to newer devices less often. Further, Cisco is increasingly facing tougher competition and cheaper offerings from the likes of Arista Networks Inc (NYSE:ANET), a company that was founded by former top Cisco executives.
Throw in the fact that more companies are experimenting with software-defined networking (SDN), and Cisco is finding itself caught between a rock and hard place. Last quarter’s results say it all: Cisco’s switching and routing revenue for the quarter fell 5% and 10% to $3.3 billion and $1.8 billion, respectively.
But CSCO has, over the past few years, been working on a grand plan that involves pushing for a recurring subscription-based revenue model. This essentially means developing businesses that will protect it from the vagaries of the boom-and-bust cycles of its core business.
Chief executive Chuck Robbins is optimistic that Cisco can leverage the lessons gleaned from its subscription-based businesses, such as Meraki cloud-controlled WiFi, Security software and Collaboration to build a solid subscription revenue businesses. Cisco’s Security segment was the brightest spot in the earnings report after growing 14% to reach $528 million. Meanwhile the Collaboration business grew 4% to hit $1,062 million.
Investors were pleased with Cisco’s latest report is because it showed that the company is making progress discovering new recurring revenue streams. The company announced that product deferred revenue related to software and subscriptions grew 51% to reach $4 billion. Meanwhile, 10% of its $9 billion Product sales is now of a recurring nature, up from virtually zero a couple of years ago.
Cash Cow and Dividend Machine
For all its troubles, Cisco remains by far the most dominant player in the networking business, something that has helped the company preserve its fat margins. During the last quarter, the company’s Product gross margin decreased from 63.4% to 61.1%, but its Services gross margin increased from 65.1% to 67.7%. Improving margins is a good sign that the company’s pricing power remains undiminished.
Healthy margins have allowed CSCO stock to become a cash cow, with annual free cash flow approaching $13 billion. Cisco spends a lot of this cash on M&A activity. During the latest earnings call, Cisco announced that it was taking AppDynamics off the IPO table by doling out $3.7 billion for the application performance management startup. But income investors need not worry — in the same vein, Cisco announced that it was hiking its quarterly dividend by 3 cents to 29 cents.
Cisco stock now yields a generous 3.5%, among the highest yields in the Dow Jones Industrial Average.
Bottom Line for Cisco Stock
Cisco instituted the dividend six years ago when it declared a quarterly payout of 6 cents, good for a modest 1.4% yield. Since then, the company has hiked dividends at least once every year.
Cisco is also sitting atop a cash hoard north of $60 billion, most of it stashed in overseas accounts. With the Trump administration looking to quickly enact legislation to lower corporate tax from 35% to 15% to 20%, Cisco will be in a position to repatriate at least some of that cash and continue rewarding investors.
The 10-year Treasury note has been rising, but at 2.52% remains well below the yield by Cisco stock. With such a healthy backdrop, Cisco stock remains a prime long-term holding especially for income investors.
As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.
