Tech stocks are back. A frenzy of M&A activity this summer, robust quarterly results in October and bright outlooks for 2011 have all helped bring fresh interest in this sector, which had been deep in the investor doghouse earlier this year. Yet one of the biggest tech stocks of all -- Cisco Systems (CSCO, Financial) -- is nowhere to be found on most analysts' buy lists. The company recently announced that business has slowed, and investors have pushed its shares down to 52-week lows.
Yet this brings out the old investor maxim: you can only make money by focusing where others are not. And right now, Cisco's road ahead deserves a fresh look. When you do, you'll find a company with considerable strengths that short-term investors are overlooking. Here are five reasons why Cisco should move back into favor in 2011.
1) The best balance sheet in the business. Cisco sports $39 billion in cash. That kind of firepower provides all sorts of financial flexibility. Cisco just announced plans to buy back $10 billion in stock and also plans to issue its first-ever dividend by the end of the year. Even with those moves, Cisco will have ample money left over to make acquisitions, maintain robust R&D, and have a nice rainy day fund.
2) It's own printing press (for money). Even as business has hit a near-term stumble, you need to note just how profitable Cisco really is, in good years and bad. The company generates gross profit margins above 60% (even though hardware is a big part of the sales mix), and operating margins routinely above 25%, which is why Cisco routinely generates around $9 billion in free cash flow every year. If you back out the $39 billion in cash noted above, then Cisco is valued at around $70 billion, which means that Cisco has a free cash flow yield of around 13%. Try to find a fixed income vehicle with that kind of yield.
3) A poorly understood M&A program. While companies like Microsoft (Nasdaq: MSFT) have largely sat on their hands and relied on the R&D team to open new markets, Cisco has pulled off dozens of acquisitions in the past few years. The company tends to focus on small outfits that possess impressive technology and are targeting large, yet still untapped market niches.
Cisco has aimed its sights on a whole range of markets, from consumer electronics to data transmission technology to enterprise-level communications tools. Trouble is, investors have never understood an overweening rationale behind the deal-making, nor has Cisco fully tapped all of those acquisitions' full potential just yet. But that's likely to change in 2011 and 2012. Now that these firms are in-house, they are tapping into Cisco's myriad resources to ensure that their products will be best-of-breed when they hit the market. The percentage of sales derived from products released in the past 12 months is at a multi-year low for Cisco for the second half of the 2010 calendar year.
But later this winter, the company believes investors will finally get to see the fruits of that M&A spree. Cisco is expected to be a key player in emerging fields such as 4G wireless networks, video streaming and device-agnostic data services. Profit growth for fiscal (July) 2011 will likely be flat, as a weak first half is offset by a somewhat better second half. More importantly, the stage is set for a rebound in growth in 2012, which will become a greater focus for analysts when quarterly results are announced in February.
4) Feet on the street. As Cisco looks to enter new markets and better capitalize on existing markets, it plans to sharply boost its sales force, adding 600 new sales staffers in coming months. New salesmen typically take six to nine months to be productive, which bodes well for rising sales toward the end of calendar 2011. And as noted earlier, analysts tend to look ahead, and Cisco will start to get credit for more robust spending on its sales force later this winter.
5) An emerging international star. Many have fretted that Cisco's core U.S. and European markets represent little growth. That's true right now, but any spending deferrals now will likely be made up for when the U.S. and European economies get back on their feet in a year or two. More importantly, Cisco is becoming a leading vendor in many emerging markets that still must spend considerable sums to develop state-of-the art technology infrastructures. Sales to countries that Cisco characterizes as "Emerging Markets" surged +32% in the most recent quarter.
Action to Take --> Cisco just took a very important step to regain investor confidence. Management sharply reduced revenue forecasts for the fiscal second quarter, which will help Cisco get back on to a path of “beat-and-raise” guidance in subsequent quarters.
Under-promising and then over-delivering is a tried-and-true formula for CEO John Chambers. He recently told investors to expect growth of +9% to +12% in the quarters ahead, down from prior guidance of +12% to +17%. As analysts at Avian Securities recently noted, “Management expects to return to the target of 12% -17% in the not too distant future.” Looked at another way, Kaufman Bros. recently wrote that “this isn't the first time CSCO has experienced a setback. In the past, the company responded well to adversity and bounced back within a few quarters.”
In the mean time, with a depressed stock price, Cisco is buying back large amounts of its own shares. You may have been burned by Cisco in 2010, but many signs point to a better 2011.
-- David Sterman
David Sterman started his career in equity research at Smith Barney, culminating in a position as Senior Analyst covering European banks. David has also served as Director of Research at Individual Investor and a Managing Editor at TheStreet.com. Read More...
Yet this brings out the old investor maxim: you can only make money by focusing where others are not. And right now, Cisco's road ahead deserves a fresh look. When you do, you'll find a company with considerable strengths that short-term investors are overlooking. Here are five reasons why Cisco should move back into favor in 2011.
1) The best balance sheet in the business. Cisco sports $39 billion in cash. That kind of firepower provides all sorts of financial flexibility. Cisco just announced plans to buy back $10 billion in stock and also plans to issue its first-ever dividend by the end of the year. Even with those moves, Cisco will have ample money left over to make acquisitions, maintain robust R&D, and have a nice rainy day fund.
2) It's own printing press (for money). Even as business has hit a near-term stumble, you need to note just how profitable Cisco really is, in good years and bad. The company generates gross profit margins above 60% (even though hardware is a big part of the sales mix), and operating margins routinely above 25%, which is why Cisco routinely generates around $9 billion in free cash flow every year. If you back out the $39 billion in cash noted above, then Cisco is valued at around $70 billion, which means that Cisco has a free cash flow yield of around 13%. Try to find a fixed income vehicle with that kind of yield.
3) A poorly understood M&A program. While companies like Microsoft (Nasdaq: MSFT) have largely sat on their hands and relied on the R&D team to open new markets, Cisco has pulled off dozens of acquisitions in the past few years. The company tends to focus on small outfits that possess impressive technology and are targeting large, yet still untapped market niches.
Cisco has aimed its sights on a whole range of markets, from consumer electronics to data transmission technology to enterprise-level communications tools. Trouble is, investors have never understood an overweening rationale behind the deal-making, nor has Cisco fully tapped all of those acquisitions' full potential just yet. But that's likely to change in 2011 and 2012. Now that these firms are in-house, they are tapping into Cisco's myriad resources to ensure that their products will be best-of-breed when they hit the market. The percentage of sales derived from products released in the past 12 months is at a multi-year low for Cisco for the second half of the 2010 calendar year.
But later this winter, the company believes investors will finally get to see the fruits of that M&A spree. Cisco is expected to be a key player in emerging fields such as 4G wireless networks, video streaming and device-agnostic data services. Profit growth for fiscal (July) 2011 will likely be flat, as a weak first half is offset by a somewhat better second half. More importantly, the stage is set for a rebound in growth in 2012, which will become a greater focus for analysts when quarterly results are announced in February.
4) Feet on the street. As Cisco looks to enter new markets and better capitalize on existing markets, it plans to sharply boost its sales force, adding 600 new sales staffers in coming months. New salesmen typically take six to nine months to be productive, which bodes well for rising sales toward the end of calendar 2011. And as noted earlier, analysts tend to look ahead, and Cisco will start to get credit for more robust spending on its sales force later this winter.
5) An emerging international star. Many have fretted that Cisco's core U.S. and European markets represent little growth. That's true right now, but any spending deferrals now will likely be made up for when the U.S. and European economies get back on their feet in a year or two. More importantly, Cisco is becoming a leading vendor in many emerging markets that still must spend considerable sums to develop state-of-the art technology infrastructures. Sales to countries that Cisco characterizes as "Emerging Markets" surged +32% in the most recent quarter.
Action to Take --> Cisco just took a very important step to regain investor confidence. Management sharply reduced revenue forecasts for the fiscal second quarter, which will help Cisco get back on to a path of “beat-and-raise” guidance in subsequent quarters.
Under-promising and then over-delivering is a tried-and-true formula for CEO John Chambers. He recently told investors to expect growth of +9% to +12% in the quarters ahead, down from prior guidance of +12% to +17%. As analysts at Avian Securities recently noted, “Management expects to return to the target of 12% -17% in the not too distant future.” Looked at another way, Kaufman Bros. recently wrote that “this isn't the first time CSCO has experienced a setback. In the past, the company responded well to adversity and bounced back within a few quarters.”
In the mean time, with a depressed stock price, Cisco is buying back large amounts of its own shares. You may have been burned by Cisco in 2010, but many signs point to a better 2011.
-- David Sterman
David Sterman started his career in equity research at Smith Barney, culminating in a position as Senior Analyst covering European banks. David has also served as Director of Research at Individual Investor and a Managing Editor at TheStreet.com. Read More...
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.
This article originally appeared on StreetAuthority
This article originally appeared on StreetAuthority
