Cisco: Upside Potential With Yield!

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Cisco (NASDAQ: CSCO) is the world’s largest supplier of computer internetworking systems, offering a complete line of routers and switching products for both local and wide area computer networks.  The company’s stock has rebounded nicely since trading at the sub-$15 level just this past July.  Investors may be wondering whether the stock is losing steam, or if there are more gains to be had.

First, let’s discuss a little about Cisco and what it does.  The company’s sales strategy is based on their 40,000 reseller partner sales representatives around the world.  Their products are divided into four segments: switches (32% of 2012 sales), routers (18%), new products (48%) and other (2%).  The company also offers extensive technical support services.

Where the most growth potential lies is the new products segment.  The company will benefit from a rapid rise in bandwidth usage and their networking expertise in order to identify new advanced technologies.  Existing “new products” consist of collaboration products, service provider video, wireless, and security products.

In addition to new products, Cisco absolutely dominates the markets it is already involved in.  For example, Cisco holds 60.3% of the world’s Ethernet switching market, making the name Cisco almost synonymous with these products.  The company also leads the routing market, with a 51.4% share of that market.  In 2010, the company introduced a new core router with three times the capacity of its predecessor.  As the world transitions toward 100-gigabit technology, this should provide a great deal of sales as Cisco’s customer base upgrades. 

Now, let’s talk about valuation and how it compares to peers.  Cisco is currently in fiscal year 2013, which ends on July 31, and consensus estimates call for the company to earn $1.96 per share for the year, meaning the stock only trades at 10.2 times current year earnings.  Earnings are expected to grow to $2.10 in FY 2014, meaning that the stock trades at only 9.5 times forward earnings.  Over the past 3 years, Cisco has traded at an average TTM earnings multiple of 14.7, meaning that if analysts’ earnings estimates are accurate, this stock could have a lot of upside.

Perhaps one of my favorite things about Cisco is the fact that it has one of the best financial profiles in the industry.  At the end of October, Cisco has $45 billion in cash and equivalents and only $16.3 billion in total debt on its balance sheet, for a net cash position of $29 billion.  Cisco has a market capitalization of $105.6 billion, as of this writing, meaning that the market is valuing its business, minus cash, at $76.6 billion. In other words, $14.48 of the price of each share represents the business and the other $5.48 represents the company’s cash.  So, subtracting cash, Cisco only trades at 7.4 times current year earnings.   

For comparison’s sake, let’s take a look at two of Cisco’s competitors, Juniper Networks (NYSE: JNPR) and Brocade Communication (NASDAQ: BRCD).  Although Cisco dwarfs both of these companies, they have very similar business models, so they make the fairest comparisons.  Juniper trades at 18 times FY 2013 consensus earnings, and when backing out the company’s cash positions, the multiple drops to 15.3.  Juniper is expected to grow its earnings at a slightly higher rate than Cisco, however I see Juniper as a significantly more risky play.  The valuation simply doesn’t justify the risk.  Additionally, Juniper pays no dividend, and Cisco yields 2.8% annually. 

On the surface, Brocade looks like a pretty cheap stock, trading at 8.6 times FY 2013 earnings.  However, Brocade is not as cash-rich as the other two, with only about $100 million in net cash (cash-debt).  Analysts also feel that the scope of Brocade’s business is much narrower than Cisco’s, and that the company’s Ethernet business has matured, meaning no significant growth is expected.

Cisco is a great company, with an outstanding balance sheet, and the most innovative products in its industry.  Being able to get into the company for 7.4 times FY 2013 earnings is an absolute gift.  Using an overall multiple of 12 times TTM earnings, which is significantly below Cisco’s historical average as mentioned above, I arrive at a 1-year price target of $25.20, or 26.3% above current levels. 

KWMatt82 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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