The Medium Term Outlook for Cisco Is Stressed

Cisco is becoming a subscription-based tech company, but very slowly

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Oct 02, 2022
Summary
  • The company is just one of the many organizations that have been impacted by supply chain dilemmas.
  • Cisco's recent results beat expectations, but it still has its share of shortcomings.
  • The transition to a software-based model has not been smooth, and competition is an ongoing issue.
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Cisco (

CSCO, Financial) is an industry leader whose technology sells across the world. In most cases, Cisco commands a lot of attention from investors. However, things look a bit tough at the moment. The company recently posted a softer-than-expected earnings report and is struggling to transition to a subscription-based model.

Cisco is also facing competition from other companies that are offering simpler, more user-friendly products. To succeed in the future, Cisco will need to find a way to make its products more accessible to the average customer. In the medium term, the outlook for the stock remains stressed as the company struggles to execute this strategy.

The subscription model has yet to fully fire up

One reason for Cisco's struggles may be the Coronavirus pandemic. The pandemic has caused corporate spending on data networks to slow down. As a result, Cisco has been forced to readjust its plans.

The evolution of the internet has changed Cisco's business. Cisco is now looking for smooth recurring cash flow from software products rather than the sale of physical goods. This move will help Cisco focus on its new mantra, "The Internet of Everything," where sensors and software enhance everyday physical objects so they can communicate and be controlled remotely. Cisco's new goal is to provide the connectivity and intelligence that powers these "Internet of Things" devices. Cisco is also shifting its business model from selling one-time hardware upgrades to offering ongoing software subscriptions. This change will help Cisco to tap into the growing trend of subscription-based software offerings, which are becoming more popular as companies look for ways to reduce up-front costs and commitment levels.

The company's recurring revenue, which includes subscriptions, rose 8% in the last quarter of 2022. The increase in revenue is good, but the company needs to explore ways to generate more income in this area. The service segment accounted for about 26% of the quarterly revenue. Over the last seven quarters, the company has averaged around 30% of total revenue. It is healthy, but investors want more traction on this end.

Supply chain issues are hurting the company

Cisco is just one of many businesses that supply chain issues have impacted. The company has suffered due to shortages of components, particularly semiconductors. Semiconductor manufacturing mainly occurs in China and Taiwan. Apart from lockdown-related manufacturing delays, freight deliveries have also been routinely late. This has delayed Cisco's manufacturing and deliveries, impacting its bottom line. Cisco is not alone in this regard; many other businesses have been similarly affected.

The main challenge lies in that component manufacturing is concentrated in a few countries, leaving businesses at the mercy of certain governments, geopolitical tensions and other factors beyond their control. To mitigate the risks posed by supply chain disruptions, Cisco has been diversifying its supplier base and looking for alternative sources of components. However, this is a long-term solution, and in the meantime, the company will continue to be adversely affected by supply chain issues.

Ultimately, this led to the company underperforming in the latest quarter. The company posted a $13.1 billion revenue for the fourth quarter of its fiscal year 2022, down slightly from the year-ago period. Adjusted earnings per share of 83 cents represent a 1% decrease over the year-ago period.

Cisco's results generally beat expectations, but the company is still struggling in some respects. For example, the move to cloud and subscription software is significantly eating into profits. Still, there are certain positives for Cisco shareholders if they look closely. Firstly, although the figures were not impressive versus the year-ago periods, Cisco still beat analyst estimates. Additionally, Cisco is forecasting earnings per share in the range of $3.49 to $3.56 and revenue growth from 4% to 6% for fiscal 2023. Both of these guidance ranges have excited the markets.

Takeaway

Cisco is a well-run company with a good management team. However, Cisco's shares are still under pressure. The company faces tough competition from peers, including but not limited to Arista Networks (

ANET, Financial) and Juniper Networks (JNPR, Financial). In addition, Cisco is facing headwinds because of a slower-than-expected transition to a subscription-based model. Under these circumstances, it looks unlikely shares will recover lost ground any time soon.

Disclosures

I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours. Click for the complete disclosure
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