Cisco: Safe Haven With Good Dividends And Strong Fundamentals
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Cisco (NASDAQ: CSCO) recently announced its strong FQ4 earnings. With a 75% increase in the dividend the company is behaving like a mature business it is supposed to be. The revenues continue to come stronger than expected while margins the margins have been stable. We believe that the momentum from Cisco’s multiple product lines can continue well going into 2013. While the macro situation is still not clear, the CEO’s commentary during the call indicated a stabilization in US. Cisco trading at a low PE ratio of 9.1 looks undervalued to us as the company continues to execute well. Hence we give it a buy rating.
Overall strong 4FQ12 metrics
Cisco posted a strong 4FQ12 as revenues at $11.69 Billion rose 4.4% YoY at the high end of guidance of 2%-5% YoY growth provided by the management. 4FQ12 EPS was $0.47 ahead of Street estimates of $0.46. Cisco’s product book-to-bill ratio in 4FQ12 was “comfortably above 1” and in line with normal seasonality. Product backlog at the end of FY’12 increased to $5.0 billion vs. $4.5 billion at the end of FY11. The operating cash flow continued the stable trend as it was clocked at $3.1B vs. $2.97B in FQ3 and $2.82B in FQ411.
Management confident amongst weak macro conditions- Pays Dividend to shareholders
We were pleasantly surprised when CFO Frank Calderoni noted that the company intends to return a minimum of 50% of its FCF to shareholders annually in the form of dividends and share buybacks. Cisco increased its quarterly dividend by 75% to $0.14 from $0.08. The higher dividend will be payable to shareholders of record on October 4, 2012 and will be paid out on October 24, 2012. Despite macro caution, management seemed confident enough in the business to increase the dividend and committed to using at 50% of free cash flow to either increase dividend, buyback stock, or both. We believe that management is confident about its ability to manage the myriad of threats from Huawei and SDN or it would not have undertaken such an aggressive return of cash to the stakeholders. We expect that the current investors will welcome the company's actions and new investors may be inclined to invest as the dividend provides an incentive to stick with a risk minimized company.
US showing initial signs of improvement
US showed improved product order growth trends in FQ4 across all major business segments except the Federal government. US state and local government product orders grew by 17% YoY in 4FQ12, up from 7% in 3FQ12. US enterprise orders increased 4% YoY in 4FQ12 compared to 1% in 3FQ12. US commercial segment orders rose 7% YoY in 4FQ12 compared to 6% in 3FQ12. Progress in US was a little offset by the decline in US Federal government orders, which declined 11% YoY in 4FQ12. While Cisco did not provide a U.S. service provider order growth number, CEO Chambers indicated that the order growth is strong from service providers and that 2H spend should be stronger. We are already confident about service provider spend to increase in 2H12 following commentary from Emcore (NASDAQ: EMKR) and Neo Photonics (NYSE: NPTN). Given the initial signs of improvement, we believe the US will be the key catalyst behind a potential spending rebound.
Software Defined Networking has vaulted to the forefront of investor concerns recently, especially after the VMWare (NYSE: VMW) acquisition of Nicira. While SDN poses a potential risk to Cisco as it may lead to the commoditization of the hardware layer, we believe that any such adjustment will take time and Cisco is likely to make acquisitions (as it has done with Insieme) and use its R&D capacity to mitigate the threats. Cisco remains well positioned to take advantage of growth in the data center with its switching and server products. We remain bullish on Cisco as it provides an upside opportunity if the economic conditions remain steady, a downside security if conditions get worse, and a healthy FCF and dividend either way.
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