Cisco (CSCO, Financial) was the darling of the internet tech boom in the late 90s. In fact, the company was dubbed “the backbone of the internet” as their devices were the heart of virtually all IT infrastructure. Cisco’s market cap reached all time highs as euphoria took hold, then as the internet bubble popped, the stock came crashing back down to earth. Over two decades later, Cisco is finally getting close to its tech bubble valuation, but this time, they have the business to back it up. Given its strong business and committment to shareholder returns, could the company offer attractive value at current levels?
Business model
Cisco is the world's leading networking company, supplying the devices that manage business internet connections globally. These devices include routers, switches, access points, etc. As a former IT Professional, I still remember the look on people's faces when I told them I was “Cisco Certified” - it was a look of admiration, as the certifications Cisco offers are some of the most challenging and well-regarded in the industry. These give the company a competitive advantage, as there is a whole community of IT professionals wearing their Cisco badge.
Cisco has been re-inventing themselves from a pure play hardware company to a hybrid cloud and services provider. According to Cisco’s Security Group :
"As much as we all talk about workloads moving to the cloud, what you find is only 15% to 20% of the workloads are moving to the cloud. Only 5% of IT spend is actually in the cloud. So, customer environment is multi IT. It's on-prem. It's in the cloud. It's in the data center."
These are huge facts to be aware of because although it may seem like Cisco is a legacy hardware provider for businesses and all IT networks are destined to move to the cloud, the actual transition by businesses is very slow, and this gives Cisco a major market opportunity with their hybrid cloud offering. Cisco also has vast expertise in end-to-end security, which becomes more important as the popularity of hybrid work increases.
(Source: Cisco Investor Relations)
Webex, a leading hybrid collaboration platform, recently hit a record 6 million users and they even scored a landmark partnership with Ford (F, Financial) offering a mobile office in Ford vehicles. Being a Cisco platform, security is expected to be a great selling point for the company, which can’t be said for other platforms such as Zoom (ZM, Financial), which was notorious for “Zoom Bombing” where random people could jump onto a call. Cisco also plans to offer enterprises private 5G networks, which would address a rapidly growing market opportunity.
Financials
Cisco currently makes 54% of their revenue from infrastructure services, 11% from applications, 7% from security and 28% from services. As the company increases its services to include more software offerings, I would expect their margins to continue to expand, as they have done since 2019. The company generated a staggering $51.5 billion in revenue for the trailing 12 months, up 4.5% year over year, with a high 63% gross profit margin and $32.6 billion in gross profits. Operating income generating over the past year was $14 billion, representing a healthy 27% operating margin.
Cisco is also spending around $6.7 billion on R&D to keep their expertise in the industry. Their balance sheet is solid with $24.5 billion in cash and short term investments and $8.97 billion worth of debt. Although the debt levels may seem high for a mature company with strong cash flows, this is not too extreme in my opinion.
The company has also continually been buying back shares and purchased a gigantic $4.8 billion worth in the last reported quarter. In the past five years, the company has reduced its share count by 16% thanks to buybacks. Dividends have also been growing at a 7.3% CAGR over the past five years, and they now pay out a healthy 2.8% yield at a 44% payout ratio.
Valuation
In terms of valuation, the stock is currently fairly valued according to the GF Value chart, a unique intrinsic value estimate from GuruFocus.
Wall Street analysts have a $64 price target for this stock, which represents upside potential of 19% if dividends are included.
Cisco is a fantastic company and still in a strong leadership position when it comes to IT infrastructure and networking. I believe the company's move towards the hybrid cloud and 5G are the right moves to make, and they are generating strong cash flows as a result. As a mature dividend-paying company, I would expect the company to maintain this moving forward.
