Cisco Systems, Inc CSCO reported earnings results for the most recent quarter last week.
The market reacted negatively to the report, and shares declined more than 11% in a single day. The stock lost almost $23 billion in market cap.
While quarterly results were better than analysts expected, it was the company's guidance for the next quarter that made investors nervous. As a result, Cisco now trades with a dividend yield that is considerably higher than its long-term average.
I think investors looking for dividend income from the technology sector should look past the short-term issues and buy shares of Cisco at current prices. Let's take a look at why.
Quarterly highlights
Cisco released its fiscal fourth quarter and full year 2020 results on Aug. 12 (the company's fiscal year ends July 31).
Revenue declined 9.5% to $12.2 billion year over year for the quarter, but managed a $67 million beat of the market's expectations. Earnings per share decreased 3 cents year over year, or 3.6%, to $0.80. This was was 6 cents higher than expected.
For full fiscal 2020, adjusted EPS was up 4% to $3.21 while revenue decreased 5% to $49.3 billion.
Source: Cisco Systems' Fourth Quarter Earnings Release, slide 6.
Results were down compared to the previous year in almost every business, with much of this decline related to the pandemic.
No segment was more impacted by the pandemic than Infrastructure Platforms. This segment had severe declines in switching, routing, data center and wireless businesses as customers cut back on spending in an uncertain environment. This is especially true for small and medium sized businesses. One bright spot was the Catalyst 9K switch, which benefited from customers updating equipment to make remote working and learning possible.
Applications continues to be a soft spot for Cisco as the sales decline accelerated during the fourth quarter. Unified communication and telepresence endpoints more than offset gains made by AppDynamics.
Revenue for Services was flat from the prior year. Advisory services were down, but maintenance revenues provided enough to overcome this headwind.
Security sales was the one segment to show growth as sales increased 10%. Cisco had strength in the areas of network security, cloud security and identity and access.
Total product orders decreased 10% for the quarter, with low double-digit declines in both the Americas and the Asia Pacific/Japan/China region. The Europe/Middle East/Africa region was down 6%. All customer segments were lower as well, led by a 23% drop in commercial orders. Product orders for the public sector were more resilient, as this segment was down just 1%.
A few bright spots included deferred revenue growing 11% to $20.4 billion. Deferred product revenue was higher by 17% and deferred service revenue was up 7%. Another plus is that subscriptions as a percentage of software revenue increased 8% to 78% of software revenue.
Cisco ended the quarter with $29.4 billion in cash and cash equivalents on its balance sheet. Lastly, the company is embarking on a $1 billion cost reduction plan as it reallocates towards higher growth areas.
Cisco has been a serial buyer of its own stock over the recent years. The share count has declined at annual rate of 2.8% over the last decade. Nearly 1.2 billion shares have been retired since 2010. However, the company did not buyback any stock during the quarter due to the uncertain operating environment. Nearly $11 billion remains on the repurchase authorization.
Negative guidance
Quarterly results were better than expected, so the report wouldn't have caused a double-digit decline on its own. What really spooked the market was Cisco's guidance for the first quarter of fiscal 2021.
The company expects revenue in a range of $11.7 billion to $11.98 billion, which would be a 9% to 11% drop from the same quarter in the prior year. EPS is seen as falling in a range of $0.69 to $0.71, which would be a 14 cent (or 17%) drop at the midpoint compared to the first quarter of fiscal 2020. Analysts have been predicting revenue of $12.3 billion and EPS of $0.76 for the quarter.
While all most companies continue to weather the ongoing pandemic, smaller and medium sized corporate customers are likely more at risk than Cisco's larger customers. Business spending among these customers could remain muted. Larger companies often have a more solid financial position, making a difficult period of time easier to manage, but smaller players often do not have this advantage.
Given this guidance, an 11.2% decrease in the share price in a single trading session seems appropriate.
Valuation analysis
While the next quarter is expected to underwhelm, not all is lost for Cisco or its shareholders. The company still sits as a leader in its industry, as 80% of all data moved over the internet over the last three decades is due to its products.
The company continues to sees strength in certain segments, such as the Catalyst 9K and security products. The sudden downturn in the stock price could present a good opportunity to add Cisco to the portfolio, for those who are interested.
Shares of the company do appear to be expensive using the traditional forward price-earnings ratio. With a share price trading at $42 and analyst consensus estimates for EPS of $3.09 for fiscal 2021, the forward price-earnings ratio is 13.6.
This isn't expensive compared to the S&P 500, which has a multiple of 29 times earnings. Compared to Cisco's 10-year average price-earnings ratio of 12.9, shares are a bit rich. The stock does look fairly valued using the five-year average multiple of 13.7 times earnings.
Where Cisco appears to be cheap is using the current dividend yield against the historical average. The stock pays a 3.4% yield at the moment. This isn't too far above the five-year average yield of 3.2%, but the average yield since the company begain paying dividends in 2011 is 2.7%. Using these two historical average yields gives us a price target range of $45 to $53. This implies a 7.1% to 26.2% return in share price if the stock were to revert to its average dividend yield range.
Final thoughts
Weaker than expected guidance led to a steep decline in shares of Cisco following the most recent earnings release. The September quarter is expected to show a decrease in results as well.
The stock is somewhat expensive in terms of the forward price-earnings ratio. Where Cisco looks like a good value is when the current yield is compared to the historical average. Including the dividend, I believe shareholders of Cisco could be looking at 10.3% to 28.8% in total return just due to a reversion to the average yield. In my opinion, this is an excellent return for a company that just offered lower than expected guidance for the next quarter.
Investors who have been waiting for an entry point into Cisco could do very well purchasing shares of the company at the current price.
Author disclosure: the author has a long position in Cisco Systems, Inc.
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