Hot technology trends come and go with fluctuating hype and investment popularity. In recent years, we have seen blockchain, cloud computing, quantum computing and artificial intelligence. But back in the early years of the internet, it was all about switches and routers. The leader back in the late 1990s and still the current leader today is Cisco Systems Inc. (CSCO, Financial).
The company is the largest provider of hardware and software solutions in the networking industry. Hardware products comprise switches, routers, data center and wireless applications. Security solutions is also an important area for the company and includes firewall and other software-defined products.
Cisco also became famous as become on of the biggest dot-com bubble stocks in 1999. After reaching high valuation levels in 1999, the stock has still not recovered from the highs it hit in March 2000.
Hardware products still represent about half of annual revenue and the company and has been trying to diversify into software and subscriptions for quite some time now. This transition to software and subscription is taking longer than many analysts expected.
Founded in 1984, the company is expected to generate $56.6 billion in revenue this fiscal year and currently has a $213 billion market capitalization.
State of the industry
The international router and switch market was valued at $50.5 billion in 2022 and is expected to grow at a compound annual rate of approximately 6.3% from 2023 to 2030. This is driven by the growth in multiple points of connectivity as well as the demand for higher bandwidth throughput.
Because of the development of cloud computing, internet of things and other technologies, the need for fast and reliable network connectivity has materially increased, which drives demand for routers and switches.
Financial review
On May 17, Cisco reported fiscal third-quarter earnings for the period ending April 2023. Revenue grew14% to $14.6 billion, primarily driven by product segment revenues increasing 17% and service revenues increasing 3%. The company continued to make progress from a one-time product sale business model to more of a recurring revenue, subscription-type service.
Annualized recurring revenue was $23.8 billion, an increase of 6% and product ARR increased 10%. Software revenue increased 18% to $4.3 billion with software subscription revenue increased 17% compared to the prior-year period.
Adjusted net income was $4.1 billion, an increase of 13%, and earnings per share increased 15% to $1. Operating cash flow was $5.2 billion for the quarter, an increase of 43% compared with $3.7 billion in the year-ago quarter.
The company has typically maintained a very safe balance sheet. At the end of the quarter, cash and short-term investments totaled $23.3 billion, while total debt was $8.4 billion. The backlog, or remaining performance obligations, increased 7% to $32 billion, of which 53% will be recognized over the next 12 months.
In the third quarter, Cisco returned $2.9 billion to stockholders through share buybacks and dividends. Cash dividends paid totaled $1.6 billion and stock repurchases totaled $1.3 billion.
Cisco CEO Chuck Robbins said, "We once again delivered a strong quarter in a dynamic environment. In Q3, we delivered record revenue and double-digit growth in both software and subscription revenue. As key technologies like cloud, AI and security continue to scale, Cisco’s long-established leadership in networking, and the breadth of our portfolio position us well for the future."
Valuation
The company has recently given annual guidance, which calls for 10% to 10.5% revenue growth and earnings per share in the range of $3.80 to$3.82. Consensus earnings estimates calls for $3.81 for this fiscal year ending July 2023 and $4.04 for the following year. However, these are non-GAAP estimates due to high levels of stock compensation paid out to the company. GAAP estimates are roughly $2.95 for this fiscal year and $3.05 for the following year. Stock compensation is a real expense, especially for tech companies and GAAP estimates should be considered. On that basis, Cisco is selling for 18 times this year’s estimates and 17 times the following year's estimates.
The GuruFocus discounted cash flow calculator creates a value of approximately $63 when using earnings of $3.81 per share as the starting point and an 8% long-term growth rate.
There are 17 Wall Street analysts that cover the company with an average price target of $55.46, a high target of $65 and a low target price of $45.
The company pays an annualized dividend of $1.56, which equates to a 2.98% dividend yield currently.
Guru trades
Guru’s who have purchased Cisco stock recently include Baillie Gifford (Trades, Portfolio) and Charles Brandes (Trades, Portfolio). Investors who have reduced their positions include Ken Fisher (Trades, Portfolio) and Chuck Royce (Trades, Portfolio).
Summary
Cisco appears to be fairly valued based on elevated multiples and lumpy growth rates. The business transformation to higher growth, recurring software and services is on track, but taking longer that expected. Nonetheless, the company is showing improved metrics in that area.
The stock is selling near the top of its 52-week range, so it may be best for investors to wait for a pullback.
