by Susan J. Aluise | May 13, 2014 1:56 pm
As networking giant Cisco (CSCO) prepares to report third-quarter earnings on Wednesday, a solid product backlog and analysts’ low expectations should help CSCO stock to a small bounce.
Analysts expect CSCO to report $11.4 billion in revenue — a 7% drop compared to the same quarter last year. The Street is looking for Cisco earnings of 48 cents per share vs. 51 cents in the year-ago quarter, so a small decline.
But for investors looking beyond this week’s financials, the outlook for CSCO stock is hazier – and very dependent on how well the company can manage powerful headwinds and tailwinds.
The good news is that Cisco CEO John Chambers has been through this rodeo more than once, and has led his company through myriad challenges in the past.
So, can CSCO stock stay strong after earnings? We check out three pros and three cons to decide:
Strong Fundamentals and Manageable Debt: Cisco has cash and equivalents of $47 billion vs. total debt of $17.2 billion, and its current ratio (a measure of liquidity) of 2.65 indicates that CSCO is in a strong position to pay its short-term liabilities, and even generate cash. Moreover, the forward price-to-earnings ratio on CSCO stock of less than 11 is attractive, particularly compared to Alcatel-Lucent’s (ALU) 21.4 and Juniper Networks’ (JNPR) 12.4. And unlike those two competitors, CSCO stock is a great dividend play at a yield of 3.3%.
John Chambers’ Bets on Acquisitions, Internet of Everything: CSCO has cut costs aggressively, fostered a collaborative work environment and is committed to strategic acquisitions including Wi-Fi equipment vendor Meraki, software defined network (SDN) firm Insieme and security expert Sourcefire. Cisco also is staking a very big claim in the so-called “Internet of Things” — machine-to-machine connectivity that can revolutionize the Internet, with Cisco’s own efforts being dubbed the “Internet of Everything.” Chambers believes some 50 billion “things” (everything from cars to toasters) will be connected to the Internet by 2020 — estimating the market value at $19 trillion. Cisco already has ponied up $150 million in IoT startups: Alchemist Accelerator, Ayla Networks and EVRYTHNG. Expect more investments in IoT this year.
The Nexus 9000 Switch: Cisco was late to the SDN party, but the company is attacking that opportunity with fresh fire and an “application-centered infrastructure.” At the core of this data center paradigm shift is CSCO’s new Nexus 9000 series switches, which launched in March. The new launch — the first product since Cisco’s Insieme deal — plays into the strategy of combining virtual and physical networks, making it easier to build new clouds. Also, the Nexus 9000 series makes it easier and more cost-effective for Cisco’s existing router customers to migrate to the SDN vision.
Resignation of Internet of Things Guru: CSCO took it on the chin last week with the resignation of IoT guru and 10-year Cisco veteran Guido Jouret. Cisco Senior VP Rob Soderbury, who most recently headed CSCO’s enterprise networking business, has stepped in to manage the group. No details were provided on Jouret’s exit except to say that he was leaving the company to “pursue other opportunities.” The exit of the Cisco’s IoT top gun could hardly have come at a worse time — CSCO has invested a quarter of a billion dollars in IoT companies so far, and strong, consistent leadership is critical to success in this burgeoning market. Expect Chambers to field questions about Jouret’s exit on the Cisco earnings call.
Declining Revenue, Earnings: Cisco earnings and revenue might beat the Street’s low expectations, but the results will almost certainly be lower than the same quarter last year. Blame the top- and bottom-line slips on two key factors: a slump in its core router and switch revenue, as well as lower sales in emerging markets like China, Russia and Brazil, which posted double-digit declines in the prior quarter after the NSA spying scandal came to light. While Cisco is working to turn those dynamics around quickly, expect these headwinds to persist to some degree throughout 2014.
Tough Competition: CSCO’s strength has always been in its high-test hardware — data center-switches and routers — and is facing significant challenges from reduced spending by service providers and a trend away from expensive hardware and toward less expensive alternatives like SDN. The SDN trend focuses on putting sophisticated software and applications on bare-bones hardware. As a result, CSCO increasingly is in a price war with competitors ALU and JNPR. Commodity pricing on network gear could rapidly erode CSCO’s margins at a time when it’s attempting to protect its dominant market position through IoT investments and using Nexus 9000 switches to counter the SDN threat.
John Chambers has done an amazing job of refocusing Cisco as a leaner, meaner competitor, but the hardware-centric market it has dominated is now changing radically. And that’s hard for any market leader that must reinvent itself quickly to hold on to its markets.
CSCO stock by no means is down for the count, but for the balance of 2014, the headwinds outweigh the tailwinds. There are three signs investors should keep an eye on:
Remember too, Chambers turns 65 in August, and retirement is looming on the horizon.
While a fire sale on CSCO stock is certainly premature, I think there will be a near-term pullback in the next couple of months.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.
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