The Sun Won't Set on This Giant

Mohsin 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) reported its second quarter earnings yesterday and the stock dipped despite a stellar quarter. The company beat estimates on both earnings and revenue estimates and provided a strong outlook for the quarter. The investors should focus on solid growth in switching, strong FCF and 8% growth in North America revenue. The only point of concern can be the shifting revenue base and the risk it is creating for the investors. I believe these earnings present a stronger case for Cisco and the stock is still a strong buy. If we compare it to a IBM, it doesn’t only provide a better dividend yield; but is trading at a cheaper valuation.

Changing Landscape

The company is currently facing a contracting economy and a changing business landscape.  As the hardware landscape evolves, the customers are not only asking Cisco to provide hardware but innovative solutions due to a radically changing enterprise environment. A very good example of this phenomenon is the recent introduction of BlackBerry’s (NASDAQ: BBRY) BB10 to the world. The new operating system is being launched in all other locations except America. The new OS has a lot of new features that have excited both techies and consumers. However, an exciting feature that stands out is the ability of this device to connect to the enterprise systems, behind the firewall. This will give users access to essential data in real time and essentially transform the hardware requirement of organizations. This is just one example of the evolving business landscape Cisco is operating in, as the company faces the challenge of providing solutions that can interconnect various sensors and handhelds.

Earnings

Cisco released its quarterly earnings yesterday and surprised the market with better than expected profits. The market was expecting Cisco to report an EPS of $0.48 and revenue of $12.06 billion. The company beat both earnings and revenue estimates by reporting EPS of $0.59 and $12.18 billion. Despite these stellar results, the company's stock lost almost 1.5% of its value on earnings.

There was a lot of good from this earnings report. Other than beating both earnings and revenue there was healthy growth in its margins, which were better than consensus at 62.3% as compared to 61.7%. The company reported healthy growth of 6.2% y/y in net income, which increased to $2.7 billion for the period. The growth in net income was driven by both better sales, lower taxes, and a more profitable sales mix.

Annual Growth

The key areas of growth were Services, Data Center, Wireless, Service Provider Video and Switching. The revenue from Switching grew by 3% y/y to $3.7, a solid growth in a mature market. The fastest growing segment was Data Centers, which grew by a staggering 65% to $0.55 billion, followed by a 24% growth in Wireless revenue, which were $0.52 billion for the period.

Service revenue grew by 10.5% at 2.6 billion and 20% annual growth in Service Provider Video revenue. The real concern for the company is negative growth in the routing segment, which declined by 6% to $1.95 billion. This decline was driven by a number of factors, including revenue timings, a maturing market and geographical shortfalls; Southern Europe and China were the most challenging regions. The collaboration revenue also fell by a significant 10% y/y to approximately $0.95 billion. This was mostly driven by shortfalls in Telepresense, which was somewhat offset by growth in conferencing, according to company management. Despite these shortfalls, the company maintained a positive outlook for the business with positive growth driven by video evolution.

Outlook

Cisco management expects growth in the range of 4% to 6%, resulting in revenue of $12.2 to $12.3 billion. The consensus revenue estimates for the quarter are $12.2 billion. Considering the positive outlook of the business, this guidance seems conservative and it seems highly likely that the company will beat consensus EPS estimates of $0.49 for the quarter.

Bottom-line

Cisco has successfully reported another stellar quarter and it seems the only way is up for Cisco. The company is giving a dividend yield of 2.7% and the stock has appreciated by 18% in the last 3 months. If we compare Cisco to International Business Machines, it doesn’t only give a higher dividend yield (IBM: 1.7%) but is still trading at a cheaper valuation. The P/E of IBM is 10.8x, whereas Cisco is trading at a P/E of 9.8x. Therefore, I believe Cisco is the best placed technology giant and the surest bet in the enterprise segment.


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