Cisco Systems — Ready for Take Off

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Jun 27, 2011
Cisco Systems Inc. (Nasdaq: CSCO) designs, manufactures and sells IP-based networking and other products related to the communications and IT industry and provides services associated with these products and their use. Additionally, the company's products and services are designed to help customers build their own network infrastructures that support tools and applications that allow them to communicate with key stakeholders, including customers, prospects, business partners, suppliers and employees.


Basis


Financial information presented herein, is based on the company's most recent SEC Form 10-K filing for year ending July 31, 2010, as filed with the Securities and Exchange Commission on September 21, 2010.


Short-Term Investment Valuation


The stock closed recently at $14.93, with first resistance at $16.42, a 10% increase from the recent close, and second resistance at $19.33, a 29% increase from the recent close. Should the stock break through second resistance, the next point of resistance is at $26.00, the stock's 52-week high.


The stock price should find support at $14.78, a 1% decline from the recent close.


Daily relativestrength is currently near 35, and appears to our untrained eye that the stock has recently bounced off of an oversold condition only to head back in that same direction.


Earnings Growth Valuation


Earnings growth valuations are based on the spread between year over year earnings growth and the current PE.


In the case of Cisco Systems Inc., the company had a year over year earnings growth of 27%, ending FY10 with earnings of $1.52 per share.


With a trailing 12-month PE currently at 10, the spread between earnings growth and the PE is 2.8, meaning that for an investor focusing strictly on earnings growth, the stock should be trading at $19.12, a $4.19 increase from a recent close.


Fundamental Investment Valuation


Liquidity: The company ended FY10 with a current ratio of 2.67, a quick ratio of 2.33, a cash ratio of 2.07, and a cash conversion cycle of 57 days. In addition, coodwill and intangibles comprised 24.6% of total assets, which, when adjusted to compensate for these items, adjusts the company's book value of $7.56 to its tangible book value of $4.15.


Profitability: FY10 found the company with a gross margin of 68%, an operating margin of 26%, a net operation margin after taxes (NOPAT) of 22%, a return on invested capital (ROIC) of 17%, and an effective tax rate of 17.5%.


Debt: The company ended FY10 with total debt of $15.284 billion, a year over year increase of 48%. additionally, the company paid an average annual interest rate 4.08%, a year over year increase of 0.7%, had a debt to cash ratio of 0.4, and a debt to equity ratio of 0.35.


Cash Flow: The company's FY10 operating cash flow was $1.93 per share, a year over year increase of 21%. The company also ended FY10 with free cash flow of $1.76 per share, a year over year increase of 23%.


Dividends: During FY10 the company did not pay a dividend.


Fundamental Valuation: Based on our review of the company's latest annual financial information we think a reasonable value estimate for the company is in the $30-$33 range.


Our Thoughts


We make no bones about it, we are not now and never have been fans of pro forma king, John Chambers.


Admittedly we have paid little attention to Cisco Systems since the tech bubble, concentrating during that time on what we believe we do best, equity research.


So it came as no surprise to us during our review of the the company's most recent SEC DEF 14A filing to find that Mr. Chambers has continued to do what he does best as well, self-promote, noting that from 1995 through fiscal 2010 he caused revenues to increase from $2 billion to $40 billion.


Portfolio Thoughts


Considering a Recent Close of $14.93, an estimated merger and acquisition payback of 8.8 years (assuming EBITDA remains the same), year over year earnings growth of 27%, year over year free cash flow growth of 23%, and our reasonable value estimate of $30-$33, we believe that on a fundamental investment basis the stock is currently UNDER PRICED, but will not consider this company as a candidate for additional research for the Wax Ink Portfolio, at least not until pigs can fly.


Disclaimer


We have no position in Cisco Systems, Inc. and no plans to initiate a position in the next five business days. Additionally, we have received no compensation to write about a specific stock, sector, or theme.