Cisco, a Conviction Tech Stock of Many Gurus
It is a very attractive company for investors despite a few bad moves it has made lately, but it is still making progress. Indeed it is part of top managers’ portfolios. Let's take a look at the performance of some of its products.
In terms of switches, the presence of Hewlett-Packard (NYSE:HPQ) in the market does not impact Cisco's dominance. Its products are highly used. In the last five-year period Cisco has been able to maintain a 60% share in the market and it seems it will remain likewise. Moreover, Cisco certification still is the standard of every industry.
What about routers? Routers, used by telecom and other cable service providers are also a favorite product. Despite the growing presence of the Chinese Huawei in emerging markets, Cisco doesn't need to worry. The demand for routers remains solid with the convergence of video, data and voice networks toward IP and with the rise of Internet traffic.
Cisco's current situation will enable it to enjoy more profits and growth to the detriment of other vendors.
In the case of UCS servers, there are evident signs of success. Although this product represents a low gross margin, it will spread Cisco's participation in its customers' data centers.
Cisco has greatly developed in 2011. It was one of the most transformative years as its partners have aggressively changed the way to do business. How can anyone get afield of this fantastic 2011? It is necessary to analyze some particular factors.
Revenue has grown to over $43 billion this year and the company expects to reduce its operating expenses by an annual $1 billion starting on 2012.
To keep the growth level achieved in fiscal year 2011, Cisco's partners have made an important decision. They have decided to optimize their portfolio. How? Cisco has significantly reduced investments in areas and products that were not so profitable. By doing so, the company has been able to allocate the money in the foundational products and services that have seen Cisco develop along the years (the products and services mentioned before).
Moreover, sales were reorganized and services and operations were restructured to have a visible horizon of the company's goals. With these changes, Cisco aims at improving productivity and being more innovative.
Least but not last, this new pathway Cisco has taken also affects shareholders, but in a positive aspect. A quarterly cash dividend is being distributed and Cisco expects to be more aggressive in terms of its stock repurchase program.
It is evident Cisco is changing for good. However, I think that there still are some risks it may suffer from.
Cisco has been growing lately. Unfortunately, that search for improvement has made Cisco lose its focus and has brought competition where companies take fiercest actions and exercise pressure, thus destroying shareholder value. If Cisco doesn't accept its size and doesn't slow down its growth rates, the company will be seriously damaged.
In the switching market, a fierce competition has arisen with HP. Although Cisco is leading the industry, there is pressure in terms of gross margin and revenue. Furthermore, its inability to compete with efficacy shows that it is unable to understand customers' needs and has not paid attention to new networking technologies.
With regard to routers, the emergence of new competitors, such as Huawei in a developing market, as the case of the Asian market, poses a risk for Cisco.
But competition is not the only problem Cisco must overcome. What about Advance Technologies (Security, Unified Communication, Storage, Wireless LAN, Home Networking, Video Systems, TelePresence, Application networking Systems and Host Small Business Systems)? Cisco has incorporated these new areas to maintain a 12-17% growth. However, some of these new businesses are in their early stages and need from three to four years to fully develop.
Another important issue is commoditization in the long term. And this threat is triggered by, on the one hand, Huawei's entry into the enterprise networking market in 2010, generating sales of $2 billion in 2010 and expecting almost $4 billion for 2011, and $7 billion for 2012. On the other hand, the emergence of a new technology, the Software Defined Networking, whose goal is to separate control and data plans within networking platforms generating discontinuity in the networking market for switching and router equipment and the emergence of merchant silicon-based networking solutions that can facilitate “white box” networking-based solutions to a broader set of networking equipment suppliers that cannot match the size and scope of ASIC development teams at Cisco.
You may be wondering whether Cisco is worth investing in. I have mentioned some risks, but read carefully and you will notice they are all long-term risks. In the short and mid-term, Cisco is deemed attractive. Indeed, some of the bad moves it unfortunately made have caused Cisco's valuation to relatively drop vis-à-vis competitors’ valuations. In the last three to five-year period, Cisco's valuation premium has been of -3%, 16% and 15% in comparison with the average multiple of HP, IBM Oracle and Microsoft, respectively. Something similar is happening with regard to the S&P 500. While Cisco is now trading at 10x NTM earnings, the S&P 500 is trading at 12x.
For an investor, this valuation fluctuation is positive. It causes the share price to lower and gives us a chance to gain a position. If you profit from this situation, you will see how right I am. Cisco management is willing to reverse the situation and to improve its results. Actually, the focus has been placed on shareholders to return cash to them. Management expects to pay $1.3 billion in dividends in 2012. I really think Cisco will try to pass first base.