Cisco: Can Cisco Begin To Generate The Growth It Needs To Push Its Share Price Higher?
For decades, Cisco (CSCO) has been a leader in the digital communications space via its expertise and strong market position in the switches and routers categories, which essentially means the hardware associated with communication in a digital network.
However, as time has moved on and the word has forged further and further into the digital age, the hardware components of network infrastructure have ceded their leadership as a growth industry to more software oriented solutions. The hardware components that Cisco is known for are being commoditized. And, this has forced the company to evolve, adopting digital security and other software-as-a-service (SaaS) solutions as a means for growth in today’s digital world.
And yet, the company continues to struggle to generate sustained growth like some of its other “old-tech” peers (such as Apple, Microsoft, and Oracle; the other Silicon Valley darlings from the dot-com boom/bust cycle that we saw roughly 30 years ago). And, with this in mind, we’ve seen an ongoing tug-of-war going on between more value oriented investors who see Cisco’s strong cash flows, balance sheet, and dividend yield versus more growth oriented investors, who want to see the company begin to expand its top-line like so many of its other peers in the technology sector.
This leads us to today’s article, which is focused on the bull/bear argument surrounding Cisco shares. The company continues to come up as a frequently discussed stock amongst the 4 and 5-star analyst community which we track with the Nobias algorithm. Today, we’ll look to see if there is a consensus, one way or the other, amongst these individuals as to whether or not Cisco is a buy, sell, or hold in today’s market.
Regarding Cisco’s pandemic performance, Richard Saintvilus, a Nobias 5-star rated analyst writing for Nasdaq.com, recently posted a piece previewing the company’s upcoming earnings report, saying, “Unlike smaller competitors such as Zoom Video (ZM) and Zscaler (ZS), which have surged amid the massive shift towards work-from-home, Cisco stock, which has fallen 1% over the past year, has been largely ignored. Are the shares undervalued or merely misunderstood?”
He continues, touching upon the company’s recent growth struggles, saying, “To be sure, the routing and switching businesses, which consists of sales of devices that are the backbone of the internet, still deliver strong cash flow for the company, despite the meager growth numbers. This business segment still accounts for some 75% of Cisco’s product revenue in the last fiscal year, while accounting for 55% of total revenue. That said, investors -- for that matter the overall market -- have been frustrated by the fact that Cisco’s quarterly revenue has fallen for four straight quarters.” But, he says “there is optimism” for the future, with investors focused on “the growth in Internet traffic.”
Saintvilus says, “Across many industries the market has witnessed increased spending on cybersecurity as employees work remotely amid social distancing norms. These trends have increased demands not only better network security, but also stronger web security as well as advanced threat solutions.” He believes that the market will be focused on growth prospects in the security space and this is where the company must deliver to maintain the upward trajectory that it has been on throughout 2021 (after struggling throughout much of 2020, CSCO shares are up 18.3% on a year-to-date basis).
Knikki Louise, a Nobias 4-star rated analyst, recently published an article on Tech Start Ups, highlighting the company’s strong performance in recent months, as well as its continued focus on digital security. She touted CSCO’s 15% performance during the month of March, saying that management’s continued aggressive M&A strategy was bullish for shareholders. Specifically, she cited the company’s recent investment in A.I. start up, Securiti, attempting to continue to grow its digital security footprint. Louise said, “The amount of data continues to grow, giving rise to both new opportunities and obligations for companies. Under broader data, there is ‘sensitive data’ that hackers usually go after, which can be misused. The emergence of multi-cloud and edge computing created a new opportunity for businesses to adopt a new architecture that could help them establish a distributed safety perimeter around multi-cloud data.”
She also highlighted a recent deal that Cisco struck with Japan’s NEC corporation, saying, “Cisco and NEC said they will work together to create new business opportunities for 5G and companies under the NEC group will collaborate with the U.S. tech conglomerate to add optimized IP metro/access transport and edge cloud computing products to the NEC’s ecosystem.”
Regarding this deal, Louise quoted Cisco’s Senior Vice President and General Manager of Cisco’s Mass-Scale Infrastructure Group, Jonathan Davidson, who said, ““We believe 5G is fueling the internet for the future and accelerating our customers’ digital transformations. Together with NEC, we are creating a powerful force to drive the critical changes needed in networking infrastructure to carry the internet into the next decade.”
Chris Neiger, a Nobias 4-star rated analyst, recently highlighted a bullish upgrade by financial firm J.P. Morgan on Cisco is his recent article titled, “Why Cisco’s Stock Popped Today”. He says, “The upgrade is based on a few things that are working in Cisco's favor, including increased IT spending in the sector, Cisco's transition to subscription revenue, and the company's "inexpensive valuation."’
Neiger also said that the J.P. Morgan analyst, Samik Chatterjee, believes that, “While Cisco's industry has had to manage a semiconductor shortage right now, as a result of higher demand for chips during the coronavirus pandemic, Chatterjee believes Cisco will be able to manage the shortage better than its peers.”
Neiger mentions that Cisco “wasn't invited to the party” with regard to the tech rally during the COVID-19 pandemic; however, he appears to be bullish on the future, saying, “Cisco is still transitioning away from its previous focus on hardware sales to more long-tail revenue from subscription services. And today's optimistic investor note from Chatterjee is definitely welcome news for investors hoping that the tech stalwart can continue its transformation.”
While CSCO’s growth has languished a bit in recent years, investors have been able to focus on the company’s low valuation (CSCO trades for just 16.5x blended earnings, which is well below the market’s multiple) and the stock’s high dividend yield (CSCO currently yields 2.8%, which is more than twice as high as the S&P 500’s current 1.34% yield). Not only is Cisco known as a reliable dividend stock, but the company has been quite generous to shareholders with its buyback program as well. Over the past 5 years, Cisco’s management team has used share buybacks to reduce its outstanding share count by roughly 16%. However, to some, even Cisco’s shareholder returns have been controversial.
For instance, Dan Weiskopf recently published a piece on Fintech Zoo which highlighted CSCO’s ongoing adoption of blockchain technology and proposed an interesting idea: why not, instead of focus on building cash on the balance sheet and returning it to shareholders, begin to build a position in bitcoin?
The idea of corporations adopting bitcoin as a balance sheet asset has been an ongoing discussion in board rooms across the world since Tesla recently made headlines, buying into the cryptocurrency in a major way (however, recent tweets by Tesla's CEO, Elon Musk, have led to speculation that the company may have recently exited its bitcoin position due to environmental/sustainability concerns).
Weiskopf says, “The future of Blockchain is about innovation, and will lead to massive industry disruption. Cisco agrees that the Blockchain is at the core of what they do and could benefit from a network effect. How business data is assimilated and processed, and even how people and clients communicate, is at the core of Cisco, yet embracing Crypto appears to be a challenge. Institutional adoption of Crypto, as measured by the price of Bitcoin and news flow, provides a single metric as evidence that momentum of the benefits of the blockchain are building. Sadly, many companies will remain solely focused on a past way of doing business and fail to innovate for their shareholders. Cisco should not be one of those.”
In his piece, Weiskopf makes the argument that as CSCO’s free cash flow multiple has risen in recent years, the company should have focused its cash flows elsewhere, as opposed to buying back shares. He says, “Obviously, hindsight is 20/20, and in 2012 buying low would have made the most sense. Over these past 3 years, Cisco has bought about $40 billion of stock back in the 11-14x multiple free cash flow basis, but demonstrated little progress in taking steps forward toward creating enterprise value like Zoom Video Communications (ZM).” He also doesn’t completely demonize buybacks as a means of capital allocation.
Nicholas Ward is a Senior Investment Analyst at Wide Moat Research. He has spent the last 8 years writing about the stock market at various publications, including Seeking Alpha, The Street, Forbes Real Estate Investor, Sure Dividend, The Dividend Kings, iREIT, Safe High Yield, and The Intelligent Dividend Investor.
Weiskopf mentioned success that other cash cow technology names have had with share repurchases, saying, “To be fair, Apple (AAPL) and Microsoft ((MSFT)) have implemented similarly aggressive buyback programs and delivered exponentially better results for their treasury, but all this points out the fact that buybacks require correctly implementing innovation strategies to deliver growth.” And, as shown above, unlike Apple and Microsoft, which are currently expected to grow their earnings-per-share by 58% and 35%, respectively, during the current fiscal year, Cisco’s expected earnings growth trajectory is flat.
Weiskopf highlights the fact that Cisco spends roughly $6 billion per year on R&D; however, this apparently isn’t generating enough return on investment, in terms of growth prospects. To combat the company’s sluggish growth, Weiskopf suggests that the company get more creative with its cash flows. He projects that Cisco will generate $43-$46 billion of free cash flow during the next 3 years and believes that the company should, literally, put its money where its mouth is when it comes to blockchain adoption in the form of crypto.
Whether or not Cisco invests it bitcoin, continues its focus on the blockchain, or digital security, or artificial intelligence, or the cloud, etc, etc, etc; it’s clear that management needs to continue to expand its footprint in the SaaS market. If Cisco is able to do that and begin to generate reliable growth again, its current valuation will likely prove to be appealing to investors. And, right now, looking at the 4 and 5-star analysts designated by the Nobias algorithm, it appears that the belief if management will be able to achieve its digital transformation, with 15 “Buy” opinions posted during the last several months as opposed to just 6 “Sell” rated opinions.
Disclosure: Nicholas Ward is long AAPL, CSCO, and MSFT. . Nicholas Ward wrote this article for Nobias at their request with a view of giving investors a balanced perspective based on the writings of Nobias highly rated analysts and bloggers. Nobias has no business relationship with any company whose stock is mentioned in this article and does not have a position in this stock.
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