This Tech Powerhouse Has 20% Upside Potential

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Against all odds, Cisco Systems (NASDAQ: CSCO) has managed to beat estimates yet again. The company reported another stellar quarter, showing further improvements in its enterprise business. The quarter also makes the case for a long-term investment in the company due to a smooth execution of Cisco's new strategic plan and stable performance despite a poor industry outlook. Analysis shows that the company has 20% upside at current levels and is a strong buy. 

Fundamental review

Technology giant Cisco recently reported its first-quarter earnings. The market was expecting Cisco to post revenue of $12.2 billion and an EPS of $0.49. These assumptions were led by a weak global economy and the attempt of Cisco to shift its business to more profitable ventures.

However, the company surprised the entire market by posting 14% year-over-year growth in EPS, which was reported at $0.51. Revenue also saw a healthy climb of 5% to $12.2 billion as compared to approximately $11.6 billion last year.

Cisco continued its strong performance with an exceptionally strong performance in NGN routing, which was slightly offset by weak services and switching segments. NGN routing saw impressive 10% quarter-over-quarter growth, while switching shrunk by 3.4%, and the services segment was flat.

The growth in NGN is another indication that enterprise demand has been strong despite fears that the company will face growth shortfalls due to a weak global economy. The bottom line was also positively affected by a product mix more tiled toward services, which resulted in a better-than-expected gross margin of 63%.

Competition

If we compare the quarterly performance of Cisco with peers, the networking giant seems to be in a much better position to face the international economic slowdown.

Juniper Networks (NYSE: JNPR) has also recently reported its quarterly earnings and disappointed the market by missing its earnings forecast. The company was hit pretty hard by the heavy spending cuts of the U.S. government, which is one of the company’s main clients. It expects the weak performance to continue and projects second-quarter revenue of around $1.1 billion and EPS in the range of $0.22 to $0.26; below analyst expectations of $0.27.

International Business Machines (NYSE: IBM) also saw its biggest single-day decline in the last eight years after reporting its first-quarter report. The company missed both EPS and revenue expectations by reporting EPS of $3.00 on revenue of $23.4 billion. The miss can be attributed to a general revenue decline across all key segments due to company’s inability to sign on more customers and a large hardware decline. Hardware sales declined 17% due to weak mainframe, x-86 and storage sales.

Outlook

The recent developments in the technology sector are pointing toward the importance of services-based business models. The slowdown in hardware sales has led to poor performance of Juniper and IBM. Cisco has been shielded by its growth in NGN routing and services and a heavy revenue mix.

Investors should focus on companies which rely mostly on services revenue or with long-term plans to focus on this segment. The strong management of IBM makes it a buy despite recent revenue shortfalls but investors are better off avoiding Juniper. There seems to be no immediate end to budget and spending cuts by the U.S. government, which is not a good sign for Juniper.

Valuations

Cisco's market performance has been nothing short of impressive. The company has given investors a +40% return in the last year along. If we take into account the weak global economy and an even weaker industry situation, this is a stellar performance by any measure. Cisco is currently trading at a forward P/E of 11.4x, compared to IBM at 11.1x and Juniper at a P/E of 13.8x.

The mean sell side target price for Cisco is $23.50, which is almost equal to current valuations. The resilience it has shown to an adverse global economy and continued performance in the enterprise segment calls for higher multiples. Using a P/E of 14x, we can establish a target price of $29 on 2014 consensus EPS estimates; a 20% return on current levels.

Bottom line

Despite a lousy economy and poor performance by the industry, Cisco has managed another stellar quarter. The company continues to astound the analysts, which is evident by yet another earnings beat. The stock is trading at a p/e of 11.4x which gives it a lot of room to expand. If we use the industry average P/E of 14x, it gives us a 20% upside on current levels. This upside combined with high earnings visibility makes Cisco a long-term buy. 

Once a high-flying tech darling, Cisco is now on the radar of value-oriented dividend lovers. Get the low down on the routing juggernaut in The Motley Fool's premium report. Click here now to get started.


Red Chip has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems. The Motley Fool owns shares of International Business Machines.. 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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