On Aug. 17, Cisco Systems, Inc. (NASDAQ:CSCO) reported earnings for Q4 and for the entire fiscal year 2016. Once again, it seems investors are underwhelmed with Cisco stock. Earnings-per-share for the quarter hit 63 cents, higher than the consensus estimate of 60 cents per share and revenues came in at $12.64 billion, slightly higher than the consensus expectation for $12.57 billion.
Cisco’s fiscal year 2016 report revealed that the security business grew by 13% year-over-year, revenue from the Collaboration business grew by 9% YOY and revenue from its Data Center segment grew by 5%. Cisco’s wireless business, while still part of the “old” core business, was able to grow by 3%.
Cisco’s routing business performed negatively, down 4% in revenues YOY, and its switching business experienced flat growth.
As a result, Cisco stock’s total revenue grew by only 3% year-over-year (excluding the sale of the SP video CPE Business), less than the 4% growth reported in fiscal year 2015.
Even the announcement of a 7% cut in Cisco’s headcount (equivalent to 5,500 jobs) failed to impress investors. Cisco stock has barely moved since the earnings release.
After a decade of sluggish growth, combined with a high dividend yield of 3%, Cisco stock is merely viewed as a cash generator, i.e. a dividend machine. But this time around, investors might be missing something. Cisco stock is making a transition — a transition into growth.
Cisco Stock: What Investors Are Missing
When it comes to Cisco, there are three elements that investors might be overlooking: Leadership, opportunity and valuation.
Leadership: Cisco has been under the new leadership of Chuck Robbins for a little more than a year now. The latest announcement of a 7% cut in the work force, with the intention of reinvesting that cost savings into growing segments, is an aggressive move.
In fact, Cisco’s staff attrition is more than the 2,850 job cuts at Microsoft Corporation (NASDAQ:MSFT) and the 3,000 job cuts at Hewlett Packard Enterprise Co (NYSE:HPE). It is a sign that Mr. Robbins is getting more aggressive in his efforts to diversify away from the routing business and into faster growing segments such as securities and “Internet of Things” technology. And it is a sign of things to come; rather than a slow shift, he is orchestrating a faster shift into growth. It also signals Mr. Robbins’ commitment to Cisco’s profit margins.
Opportunity: Despite sluggish revenue growth, Cisco overwhelmingly dominates the Data Network industry with roughly 60% market share in Ethernet switching market. This dominance allows Cisco to create a symbiotic business model with its faster growing business of security, collaboration and data. These symbiotic possibilities and Cisco’s dominance in the industry can pave the way for a much stronger foothold in growth areas. On top of it, Cisco has piles of cash, with $12.7 billion of free cash flow generated in fiscal year 2016. This gives Cisco plenty of firepower to buy smaller companies and accelerate its entry into new businesses.
Valuation: Valuation is, perhaps, the most important element, because if Cisco stock valuation were rich, then all of the aforementioned possibilities would have already been priced in. Yet that is not the case; Cisco stock is currently trading at 15X earnings multiple, compared with the industry average of 24X.
Furthermore, Cisco stock’s dividend yield is 3%, compared to the industry average of 2.5%. In other words, CSCO stock trades at a discount to its peers and pays a higher dividend. Together, that leaves room for upside in the stock when growth starts to pick up, but also cushions some of the downside risk.
The Bottom Line on CSCO
There is no denying that Cisco stock results are somewhat mild and, so far, CSCO has yet to show tangible improvement in its business. But the latest job cuts and the recent emphasis on growing segments suggest that change might be coming quicker. Moreover, Cisco’s relatively low valuation and high dividend leaves room for upside if and when that change comes.
As of this writing, Lior Alkalay did not hold a position in any of the aforementioned securities.