Stock of the week - Cisco Systems (16.05.2024)

• Cisco Systems reported fiscal-Q3 results on Wednesday
• Earnings turned out to be better-than-expected
• Company boost full-year revenue forecast
• Spike in remaining performance obligation
• A look at valuation
• Shares erased premarket gains after cash session launch

Cisco Systems (CSCO.US) reported results for fiscal-Q3 2024 (February - April 2024) yesterday after close of the Wall Street session. Results turned out to be better than expected and, on top of that, company decided to boost the full-year revenue outlook. Release triggered a jump in company's share price in the after-hours trading, but those gains have been quickly erased at the start of Wall Street session today. Let's take a closer look at Cisco earnings, valuation and situation on the chart!

Fiscal-Q3 results beat expectations

Cisco Systems reported fiscal-Q3 2024 results that were better than expected all across the board. While company's total revenue dropped, it still came slightly above analysts' expectations, with revenue beats being reported in both key categories (product & service). Product revenue beat was driven by beat in Security revenue. While revenue dropped, cost of revenue dropped even more, hinting at improvement in efficiency. While gross and operating income dropped compared to a year-ago, margins improved. Company declared a $0.40 dividend per share, in-line with market expectations.

However, a period of weaker revenue growth may be coming to an end, with company reporting significant growth in remaining performance obligation, which can be seen as a kind of order backlog for software companies. Cisco said that orders were up 4% during the quarter, with growth being driven by data center and campus switching orders. This suggests that company are once again increasing spending on computer networks.

Fiscal-Q3 2024 earnings

• Revenue: $12.70 billion vs $12.66 billion expected (-12.8% YoY)
  • Product revenue: $9.02 billion vs $8.95 billion expected (-18.6% YoY)
    • Networking: $6.52 billion vs $6.49 billion expected (-27.4% YoY)
    • Security: $1.30 billion vs $1.17 billion expected (+36.1% YoY)
    • Collaboration: $987 million vs $989.7 million (+0.2% YoY)
    • Observability: $211 million vs $314.2 million (+26.4% YoY)
  • Service revenue: $3.68 billion vs $3.59 billion expected (+5.7% YoY)
• Adjusted cost of revenue: $4.03 billion vs $4.17 billion expected (-20.6% YoY)
• Adjusted gross profit: $8.67 billion vs $8.42 billion expected (-8.7% YoY)
  • Adjusted gross margin: 68.3% vs 66.9% expected (63.4% a year ago)
• Adjusted operating income: $4.35 billion vs $4.17 billion expected (-12% YoY)
  • Adjusted operating margin: 34.2% vs 33.1% expected (33.9% a year ago)
• Adjusted net income: $3.55 billion vs $3.35 billion expected (-13.6% YoY)
  • Adjusted net margin: 28.0% vs 26.4% expected (28.2% a year ago)
• Adjusted diluted EPS: $0.88 vs $0.82 expected ($1.00 a year ago)
• Dividend per share: $0.40 vs $0.40 expected ($0.39 a year ago)
• Annual recurring revenue: $29.2 billion vs $29.46 billion expected (+22.7% YoY)
• Remaining performance obligation: $38.8 billion (+20.9% YoY)

Financial dashboard for Cisco Systems. Source: Bloomberg Finance LP, XTB Research

Cisco boosts full-year revenue forecast

Apart from releasing better-than-expected fiscal-Q3 2024 results, Cisco Systems also issued new forecast for fiscal-Q4 and full-year fiscal-2024. Guidance for fiscal-Q4 came in mostly in-line with market expectations. However, a lot of attention is being paid to full-year revenue forecast as it was boosted significantly. Full-year adjusted EPS forecast was narrowed, with new midpoint ($3.70) being slightly below midpoint of previous guidance ($3.71). When it comes to fiscal-2025 (August 2024 - July 2025), Cisco Systems expects low-single digit revenue growth.

Fiscal-Q4 2024 forecast

• Revenue: $13.4-13.6 billion vs $13.54 billion expected
• Adjusted gross margin: 66.5-67.5% vs 67.4% expected
• Adjusted operating margin: 31.5-32.5% vs 32.5% expected
• Adjusted EPS: $0.84-0.86 vs $0.84 expected

Full-year fiscal-2024 forecast

• Revenue: $53.6-53.8 billion, up from previous forecast of $51.5-52.5 billion
• Adjusted EPS: $3.69-3.71, compared to previous forecast of $3.68-3.74

Cisco Systems expects fiscal-Q4 2024 revenue to remain lower than a year ago (orange circle), but drop is expected to be smaller than in fiscal-Q3 (-11.2% vs -12.8%). Source: Bloomberg Finance LP, XTB Research

Acceleration in performance obligation growth

The outlook offered by Cisco Systems for full-year fiscal-2024 and, especially, full-year fiscal-2025 is seen as conservative. Full-year fiscal-2024 revenue is expected to be almost 6% lower than in fiscal-2023. Outlook for positive growth in fiscal-2025 is welcome, but 'low single-digit growth' looks conservative given significant acceleration in remaining performance obligation in recent quarters. Total performance obligation increased almost 21% YoY, with Service performance obligation spiking almost 30% YoY.

Source: Bloomberg Finance LP, XTB Research

A look at valuation

Let's take a quick look at Cisco Systems valuation with 3 often used valuation methods - DCF, multiples and Gordon Growth Model. We want to stress that those valuations are for presentation purposes only and should not be viewed as recommendations or target prices.

Discounted Cash Flow

Let's start with probably the most popular fundamental model for valuing stocks - Discounted Cash Flow method (DCF). This model relies on a number of assumptions. We have decided to take a simplified approach and base those assumptions around averages for the past 5-years. Detailed forecasts for 10 years were made, with terminal value assumptions being set as follows - 2% terminal revenue growth and 7% terminal weighted cost of capital (WACC). Such a set of assumptions provides us with an intrinsic value of Cisco Systems shares of $64.36 - over 20% above current market price. Terminal value forecast accounts for around 61.7% of DCF valuation.

A point to note is that the intrinsic value obtained via the DCF method is highly sensitive to assumptions made. A sensitivity matrix for different sets of Operating Margin and Revenue Growth assumptions have been provided below.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Multiples

Next, let's take a look at how Cisco valuation compares with peers. We have constructed a peer group consisting of 9 companies, each of whom was named in Cisco's latest annual report as a competitor. The group includes Arista Networks, Juniper Network, Broadcom, Ciena Corporation, Dell Technologies, Fortinet, Hewlett-Packard Enterprise, Palo Alto Networks and Zscaler. We have taken a look at 6 different multiples - P/E, P/S, P/BV, P/FCF, EV/Sales and EV/EBITDA.

Averages for different multiples have been calculated. As one can see in the table below, there is quite a significant volatility in the data for different companies. We have decided to use median multiples in valuation calculations as they seem to be less distorted by outliers and are also more conservative compared to mean and cap-weighted averages. As one can see in the table below, most of the valuations obtained this way are significantly above current market price. Trimmed average of those median valuations (excluding the highest and the lowest level) suggest an intrinsic value of Cisco Systems shares of over $116 - over 100% above current market prices.

Source: Bloomberg Finance LP, XTB Research

Gordon Growth Model

Let's move to the third valuation method - Gordon Growth Model. This method relies on dividends and given that Cisco Systems is a dividend-paying stock, it can be used to value company's stock. We have assumed an 5% dividend growth rate as well as historical average required rate of return of 9%. Such a set of assumptions provides us with a valuation of $40.43 per Cisco share - over 20% below current market price.

As it is usually the case with valuation models, the Gordon Growth Model is also highly sensitive to assumptions made. Sensitivity matrix for dividend growth and required rate of return assumptions are provided below. Green tiles show combinations that result in above-market valuation, and red tiles show combinations that result in below-market valuations.

Source: Bloomberg Finance LP, XTB Research

A look at the chart

Cisco Systems (CSCO.US) jumped around 5% in the after-hours trading yesterday, following release of fiscal-Q3 earnings report. However, those gains have been gradually erased throughout today's premarket trading. As a result, stock launched today's cash session just slightly higher and has quickly erased those gains.

Taking a look at chart at D1 interval, we can see that the stock opened near resistance zone in $50 area. A quick pullback at the start of the session has pushed the stock below yesterday's closing levels. However, this drop was halted at the 50-session moving average and the stock managed to recover part of the losses.

Source: xStation5