It’s Time to Rethink How We Value Cisco Systems, Inc. (CSCO) Stock


Most of the headlines are tilted bullishly, suggesting Cisco Systems, Inc. (NASDAQ:CSCO) is a buy today, with CSCO stock selling off to the tune of 5%. Those bullish calls are supported by rather sound arguments too, not the least of which implores investors to look beyond just one quarter.

It's Time to Rethink How We Value Cisco StockAnd yet, those headlines arguably oversimplify the uncertainty current and would-be owners of Cisco stock face today.

On the one hand, the disappointing first fiscal quarter of 2017 doesn’t necessarily reflect the product/service mix that CSCO stock will be sporting a year or two from now. On the other hand, two key product categories showed decided weakness for the company last quarter, and there’s nothing Cisco can do to re-inflate demand on those fronts.

Investors have a lot to think about here.

Cisco Stock: A Tale of Transition

For the quarter ending in October, CSCO earned 61 cents per share on revenue of $12.35 billion. Both figures topped analyst estimates for a bottom line of 59 cents per share of CSCO and sales of $12.33 billion.

So why the sharp selloff from Cisco stock?

It’s partly a response to the fact that the networking giant drove $12.68 billion in revenue for the same quarter a year earlier. It’s mostly the result, however, of a lackluster outlook and poor results from CSCO’s core business lines. Sales for its telecom service provider division were particularly poor, falling 12% on a year-over-year basis. Its switching business as a whole fell 7% during fiscal Q1.

The lull represents a macro headwind, according to CEO Chuck Robbins, who explained that “[some customers have] just stopped spending as they tried to figure out what is going on in their business.”

The macro headwind isn’t just in Robbins’ head either — others are seeing it too. Pacific Crest analysts Alex Kurtz and Steve Enders commented after Wednesday evening’s report: “Despite the setback in the U.S. service provider market, which appears unrelated to product or competitive positioning … we would see any material pullback in the stock as a buying opportunity.”

The question is, how long will the macro headwind last? Nobody seems to know for sure. Needham Co analyst Alex Henderson thinks it’s going to persist for a few more quarters. Cisco at least partially obliged by forecasting a 2% to 4% revenue decline for the quarter currently underway.

Either way, it’s a shift that’s been underway for longer than most CSCO stock investors recognize.

The shift is also one of the key reasons Cisco has been moving toward a software and service-oriented business model that drives more recurring revenue. The company demonstrated progress on that front too. Last quarter, service revenue grew 7%, and security revenue was up 11%.

CSCO aims to add cloud-computing management and security to its ‘campus’ portfolio of products within a year.

The Real Problem With CSCO Stock

It’s all a step in the right direction. As yesterday’s hardware functions are increasingly virtualized and technological leaps become more difficult to muster, Cisco must make that move to be competitive.

The upside is regular, reliable revenue, even if it’s not the kind of revenue tallies the market has come to expect from the networking company.

CSCO is handling the shift so adeptly, in fact, that Bernstein reiterated its buy stance on Cisco stock, noting:

“Cisco is hit by unfavorable macro, and although this is painful and may last for a few more quarters, it shouldn’t deteriorate much further than what today’s guidance implies. Beyond this, underlying business trends are excellent, with fast and accelerating growth in subscription revenues. The latter is becoming more and more visible every quarter and is likely to support the stock price through a difficult macro environment. We are therefore buyers of the pullback today and reiterate our Outperform rating with a price target of $35.”

And, the call’s premise is on target. What might be a bit off-base is the justification of a $35 target price.

The Wall Street Journal’s Dennis Berman may have summed it up best when he opined:

“They’re telling us revenue is down next quarter so again this is a company that has to manage its calls, manage its capital spending. It’s not a growth stock in the way that we perceived it 15 years ago or even 10 years ago. It’s just sort of a solid value stock at this point.”

CNBC “Fast Money” commentator Guy Adami added:

“I will say this $30 is where it bounced up against all last year and failed,” Adami said. “We’re trading around there now so as resistance becomes support it better hold basically this $30 level.”

And there’s the rub. The more Cisco transitions to a recurring revenue outfit, the more difficult it becomes to value CSCO stock as a growth play.

That’s new territory for most investors, who have yet to tamp down their expectations accordingly. That’s not going to prevent the reality from bearing down on Cisco stock as traders figure it out though.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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