Cisco Continues to Rise

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The past couple of years have been difficult for Cisco (NASDAQ: CSCO), the global leader in networking equipment, as it started focusing on the server market and its Unified Computing Service platform became its priority from 2010. Since January 2010 until the end of 2011, its stock had fallen by more than 24%. As I have discussed in an earlier article, the turnaround was essential for Cisco to survive and rebuild a long term growth path, and this is now becoming more and more apparent.

In its previous quarter-- the last of its financial year -- Cisco posted better than expected results that saw revenues and profits rising by 5% and 55%, respectively, year over year. The improvement came on the back of not only its aggressive cost cutting strategy but its ability to attract new orders from Asian and U.S. firms.  As a result, Cisco is also increasing its dividends from $0.08 to $0.14 per share. 

Cisco has now taken this positive momentum forward into its fiscal 2013’s first quarter ending Oct. 27, 2012, in which sales and net income increased by 5% and 18%, respectively, year over year to $11.9 billion and $2.1 billion, respectively. Again, effective cost cutting strategies as well as price reductions were the reason behind Cisco’s ability to top analysts’ estimates.  Volume gains implied by these results show that the company has gained market share.  Non-GAAP EPS was $0.48 versus the estimated $0.46 per share. The company’s stock has been up 2.5% from the start of July 2012.

 Almost 80% of Cisco’s revenues come from its Products division, with switching equipment forming 30% of the total revenues. The company is now the second biggest player in the x86 blade server market in the U.S. and third biggest in the world.

However, despite the upbeat results, the future isn’t any less challenging. The slowdown in the European and U.S. economies is translating into weak demand. Moreover, the upcoming fiscal cliff in the U.S. is creating more uncertainties. Although Cisco was able to increase its U.S. enterprise revenue by 9% year over year, the revenues from switches and routers-- that form around half of the company’s business-- fell by 2% year over year on weak demand. This in turn dragged the entire product revenue growth, which increased by just 4% year over year.

On the other hand Cisco’s peers, such as IBM (NYSE: IBM), Intel (NASDAQ: INTC), and Ericsson (NASDAQ: ERIC), have posted falling quarterly income by 0.42%, 14.30%, and 43%, respectively. In such an environment, Cisco’s results lifted the gloom from Wall Street. 

Both Cisco and Intel have been neck and neck in terms of gross margins that hover around 60%, but on a year over year basis all three (including IBM) have been fairly stable with small changes. On the other hand, Ericsson’s gross margins are declining and have fallen from 35.4% in Sep 2011 to 31.2% in Sep 2012. Ericsson is bearing the brunt of the European debt crisis as local carriers reduce their spending. Moreover, the fierce competition on the continent from Huawei and ZTE is making things worse.

<table> <tbody> <tr> <td> </td> <td> <p><strong>Cisco</strong></p> </td> <td> <p><strong>IBM</strong></p> </td> <td> <p><strong>Intel</strong></p> </td> <td> <p><strong>Ericsson</strong></p> </td> </tr> <tr> <td> <p><strong>Stock YTD</strong></p> </td> <td> <p><strong>-2.31%</strong></p> </td> <td> <p><strong>1.75%</strong></p> </td> <td> <p><strong>-22.64%</strong></p> </td> <td> <p><strong>-12.85%</strong></p> </td> </tr> <tr> <td> <p><strong>P/E</strong></p> </td> <td> <p>11.39</p> </td> <td> <p>13.33</p> </td> <td> <p>8.7</p> </td> <td> <p>13.85</p> </td> </tr> <tr> <td> <p><strong>EPS</strong></p> </td> <td> <p>1.55</p> </td> <td> <p>13.91</p> </td> <td> <p>2.29</p> </td> <td> <p>0.62</p> </td> </tr> <tr> <td> <p><strong>Yield</strong></p> </td> <td> <p>3.30%</p> </td> <td> <p>1.80%</p> </td> <td> <p>4.40%</p> </td> <td> <p>2.80%</p> </td> </tr> <tr> <td> <p><strong>ROA</strong></p> </td> <td> <p>7.50%</p> </td> <td> <p>12.06%</p> </td> <td> <p>13.87%</p> </td> <td> <p>3.60%</p> </td> </tr> <tr> <td> <p><strong>ROE</strong></p> </td> <td> <p>16.73%</p> </td> <td> <p>73.84%</p> </td> <td> <p>24.95%</p> </td> <td> <p>9.50%</p> </td> </tr> </tbody> </table>

For its next quarter, Cisco is aiming to increase its revenues by 3.5% to 5.5% year over year with an EPS of $0.47-$0.48. The company still has a low valuation. Its current P/E of 11.4 is about 28% below its five year average of 15.7, as investors are still not handicapping Cisco as a growth story again.  Its wireless segment contributes just 4% to revenues, but its 38% growth in this quarter from last year means that Wi-Fi will play an important role in the company’s future. As seen in 24 previous quarters – not consecutive though– Cisco’s service revenues have posted double digit growth numbers of 12% to $2.6 billion.  The company’s gross margins are 66% from Service and 60% from Products.

Cisco’s concerns of losing U.S. market share due to the rise of Chinese telecom equipment manufacturers Huawei and ZTE were alleviated in September when the U.S. House Intelligence Committee put a dent on the reputation of the Chinese firms by claiming that they pose a “security threat” to the U.S national interest. However, Cisco will continue to face competition from Huawei and ZTE in almost every other part of the world.

Huawei is now gearing up for Europe, Huawei’s “second home,” and Ericsson’s primary market. In a striking contrast to the U.S. action, Ren Zhengfei, the CEO of Huawei, was welcomed in Britain by none other than the Prime Minister David Cameron himself, just a few weeks after the release of the U.S Intelligence Committee report. The company has already made investments of around $2 billion in Britain, while it has a more than 7,000 people in its European workforce. Huawei is one of the key suppliers of British telecom firms such as BT. While Cisco is avoiding any further investments in Europe, which is smart for a company still completing its re-imaging, Ericsson is being pushed to the company's lowest margins in more than 20 years and Huawei is aiming to add another 700 jobs and a research center in Britain by 2017.

PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of International Business Machines and Intel. Motley Fool newsletter services recommend International Business Machines and Intel. 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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