Cisco (CSCO, Financial) delivered its fiscal first-quarter 2017 earnings last week with a 1% sales growth to $12.4 billion and 4% profit loss to $2.3 billion.
"We had a good quarter despite a challenging global business environment, and we performed well in our priority areas.
"We are leading our customers in their digital transition by providing them with highly secure, automated, and intelligent solutions in the ways they want to consume them. Our innovation pipeline is robust and we are well positioned for the future." – Chuck Robbins, CEO, Cisco
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The $155 billion technology company reported a 189% increase to $411 million in relation to restructuring expenses that had let to lesser overall profits (1).
(Outlook, Press Release)
Cisco also forecasted that it would have -2% to 4% lower sales in its fiscal second-quarter 2017 and -32.3% to 24% lower in generally accepted accounting principles (GAAP) earnings-per-share (EPS) (2).
As observed, Cisco would have excluded SP Video CPE Business from its forecast. The company also had excluded it in previous quarterly filings whereby the company delivered good sales and earnings growth with SP Video CPE exclusion (3)(4). Nonetheless, Cisco stated that the excluded business had generated sales amounting to $93 million in fiscal second-quarter 2016.
As a result of its weak outlook, Cisco shares traded at about three times heavily (volume) the following day and closed -4.8% while the Standard & Poor’s 500 index closed 0.47%.
Valuations
Cisco had a trailing 12-month price-earnings (P/E) ratio of 14 times (industry median: 19), price-book (P/B) ratio of 2.39 times (industry median: 1.68) and (P/S) ratio of 3.13 (industry median: 1.28) (5). The tech company had a trailing 12-month dividend yield of 3.28% and a 45% payout ratio and 2.3% buyback ratio.
Market performance
(Annual filing)
Cisco had a total five-year return of 12.87% while the broader market had 14.86% (6). Year to date, the company returned 14.79% while the latter provided 8.87%.
Cisco
Cisco was founded more than 30 years ago; the company designs and sells broad lines of products, provides services and delivers integrated solutions to develop and connect networks around the world (7).
Cisco operates its business globally. The business is organized into the following three geographic segments: Americas (60% of fiscal 2016 sales); Europe, Middle East, and Africa (EMEA, 25% of fiscal 2016 sales); and Asia Pacific, Japan, and China (APJC, 15% of fiscal 2016 sales).
Cisco also reports nine different product categories and service: Switching; Next-Generation Network (NGN) Routing; Collaboration; Data Center; Wireless; Service Provider Video; Security; Other Products; and Service.
(Annual filing)
As shown in the image above, Cisco receives 30% of its business from its switching business segment (30% of fiscal 2016 sales), followed by services (24%) and NGN Routing at (15%).
Switching
Switching, according to Cisco, is an integral networking technology used in campuses, branch offices and data centers. Switches are used within buildings in local-area networks (LANs) and across great distances in wide-area networks (WANs).
(Cisco’s key product platforms for its switching product category, annual filing)
Cisco’s switching products offer many forms of connectivity to end users, workstations, IP phones, wireless access points and servers and also function as aggregators on LANs and WANs.
Switching products grew flat year on year in fiscal 2016 to $14.75 billion in sales. For fiscal first-quarter 2017, switching products sales declined by 7% to $3.7 billion, compared to the same quarter last year.
NGN Routing
(Key product areas of Cisco’s NGN Routing product category, annual filing)
The technology associated with Cisco’s NGN Routing interconnects public and private wireline and mobile networks for mobile, data, voice and video applications. NGN Routing has a portfolio of hardware and software solutions consist primarily of physical and virtual routers and routing and optical systems.
NGN Routing products grew -3.8% in total fiscal 2016 sales to $7.4 billion. For fiscal first-quarter 2017, NGN Routing sales grew by 6% to $2 billion, compared to the same quarter last year.
Service
Cisco also provides a broad range of services, including technical support and advanced services. These technical services help Cisco’s customers protect their network investments, manage risk and minimize downtime for systems running mission-critical applications.
Cisco’s advanced services program, meanwhile, supports networking devices, applications, solutions and complete infrastructures for its customers.
(Cisco, Company Website)
The product and categories (includes switching products to security) segment lost 1.3% in fiscal 2016 sales while the service segment grew 5.1% for the period. Also, the product and categories segment had a gross margin of 62% while the service segment had 65.6% in fiscal 2016.
For fiscal first-quarter 2017, the product and categories segment lost 1% to $9.3 billion, while Cisco’s services grew 7% to $3 billion. Product and categories had a gross margin of 63.8%, while services had 65.1%.
Overall, Cisco had five-year sales and profit growth averages of 2.65% and 10.6% (6).
Acquisitions in 2016
(Annual Filing)
In addition to its growing business, Cisco also had an active year in fiscal 2016 acquiring several tech companies that are oriented to its business model.
Cash, debt and book value
As of Oct. 29, Cisco had $10.4 billion in total cash and cash equivalents and investments available in the U.S. Meanwhile, the tech company had $70.97 billion in cash, cash equivalents and investments for the period.
Cisco also had $34.8 billion in debt with a debt-equity ratio of 0.55. The company also had 23% of its $126.3 billion assets in goodwill and intangibles, having a book value of $63.4 billion in book value.
Cash flow
(Cash flow, company Web site)
Cisco delivered percentage growth in its cash flow from operations to $2.7 billion for its fiscal first-quarter 2017. The company allocated $275 million in capital expenditures, leaving it with $2.46 billion in free cash flow.
As observed, Cisco allocated part of its cash flow to investments. Cisco also placed $18.67 billion in the said investments, while receiving $13.79 billion from proceeds from sales and maturities of these investments.
For the period, Cisco took in about $6.23 billion in debt. The company issued $2.3 billion, or 94.9% of free cash flow, in dividends and share buybacks.
(Cash flow from financing, Annual Report)
In review, Cisco seemed to have added more debt in the recent three fiscal years than it was able to reduce. Meanwhile, the company also has been able to buy back more of its shares than it had issue.
(Free cash flow and payout, annual filing)
Cisco demonstrated disciplined cash flow allocation when it comes to its shareholder payouts, such as dividends and share buybacks combined. In recent years, the company had reduced its free cash flow payout ratio down to a more conservative level of less than 75% ratio.
Conclusion
Cisco demonstrated the capacity to grow and maintain its presence in the highly competitive technological field. Despite the ongoing presence of cloud computing and other innovative developments, Cisco had maintained an acceptable growth pace and margin in its product offerings.
Also, Cisco has a strong and healthy balance sheet accompanied by a growing amount of cash flow over the years.
The company, meanwhile, expects a weaker outlook for its fiscal 2017 second quarter. Cisco also traded at a discount to its peers for this period despite being able to outperform the broader market in both the short  and long term.
(Google Finance)
On Nov. 18, analysts in Stifel rank Cisco as a hold with a target price of $34 a share. Deutsche Bank, meanwhile, had a buy rating on the company with a target price of $37 a share back in September. Five-year earnings multiple average and profit growth with a 20% margin indicated a value of $35 a share (8).
In summary, Cisco is a cautious buy with a target price of $35 a share.
Notes
(1) Press release: Cisco currently estimates that it will recognize pretax charges to its GAAP financial results of up to $700 million consisting of severance and other one-time termination benefits and other associated costs.
These charges are primarily cash based. Cisco expects that approximately $125 million to $175 million of these charges will be recognized during the second quarter of fiscal 2017 with the remaining amount to be recognized during the rest of the fiscal year.
(2) I used 62 cents as a point of comparison in Cisco’s diluted EPS figure back in the quarter ended on Jan. 23. I also used 42 cents and 47 cents GAAP EPS mentioned in the image from the press release.
Link: Where I obtained 62 cents
(3) Press release: Cisco divested the Customer Premises Equipment portion of the Service Provider Video Connected Devices business ("SP Video CPE Business") during the second quarter of fiscal 2016 on Nov. 20, 2015.
(Second-quarter fiscal 2016 GAAP results, red ink by me)
(4) GuruFocus data.
(5) Morningstar data.
(6) Annual filing.
(7) My calculations.
Disclosure: I do not have shares in Cisco.
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