Published Jan. 22 by Bob Ciura
Cisco Systems (CSCO, Financial) has an impressive dividend yield of 3.6%. It’s even more impressive considering Cisco is a tech stock.
It wasn’t too long ago that the mere mention of Cisco paying a dividend to shareholders was almost considered sacrilege.
During the tech sector’s heyday of the late 1990s, tech CEOs scoffed at the idea of paying dividends. Dividends were something utilities did, because they had no better use of capital.
What a difference a bubble bursting makes…
After the tech bubble popped, stocks across the tech sector lost half their value or more. The 2008 to 2009 Great Recession was another painful reminder of the margin of safety provided by dividends.
Since then, tech companies like Cisco and many others have initiated and grown dividends for several years. In fact, the company has increased its dividend payments every year since it initiated a dividend in 2011.
Cisco typically raises its dividend each year in February. That means another raise is right around the corner.
The 2017 increase will mark the company’s sixth straight year of annual increases. It’s likely Cisco’s dividend streak continues into the future. The company will make the Dividend Achievers list in four more years (if dividends continue to rise).
The Dividend Achievers List is comprised of 272 businesses with 10-plus years of consecutive dividend increases. It is an excellent place for dividend investors to find stocks with a history of rising dividends. You can see the full Dividend Achievers List here.
Business overview
Cisco is a global technology giant. It provides services and solutions to develop and connect networks around the world.
It has a highly-diversified business, both in terms of operating geography and product offerings.
Source: 2016 Annual Report, page 6
Approximately 40% of Cisco’s total revenue comes from outside the U.S., and it generates revenue from nine individual product segments.
The beauty of a large-cap tech company of Cisco’s size is that it generates extremely high profit margins. Cisco’s gross margin expanded 250 basis points in 2016, to 62.9%.
Source: 2016 Annual Report, page 6
At the same time, this is a period of transition for Cisco.
It has placed greater emphasis on shifting its business model to recurring revenue. Deferral revenue increased 8% to $16.5 billion in fiscal 2016. The recurring portion of its deferred revenue increased 33% last year.
Going forward, Cisco is also facing a transition within its core operations. Nearly half of its sales are still derived from routers and switching, which are low-growth industries that have nearly reached saturation in Cisco’s core markets.
The company is seeking to provide services and solutions both on premise and in the cloud.
There is good reason for the shift. Combined, revenue from routers and switching declined 1% in fiscal 2016. In response, the company is investing heavily in growth areas of the future.
Growth prospects
Cisco’s growth going forward will be fueled by its three strategic focus areas: data centers, wireless and security.
Together, these three businesses account for just 16% of Cisco’s total revenue. But this is poised to change, because these segments are growing rapidly.
The three segments cumulatively increased revenue by 6% in fiscal 2016.
The growth rates would be even more impressive were it not for the strong U.S. dollar. This has eroded Cisco’s revenue growth, since it collects such a significant amount of revenue from international markets.
Growth in these areas should accelerate in 2017 and beyond, because the company has conducted numerous acquisitions over the past year in these specific areas.
Cisco made 12 acquisitions in 2016 in IoT, the cloud, security and other pivotal growth segments.
It is hard to bet against Cisco, which has one of the most impressive research and development platforms in the entire tech industry.
Source: 2016 Annual Report, page 9
Cisco’s growth is the result of what the company calls its “innovation engine.” It fuels this engine with significant R&D expense:
- $6.3 billion of R&D expense in 2016.
- $6.2 billion of R&D expense in 2015.
- $6.3 billion of R&D expense in 2014.
Its effective R&D and strong brands allow the company to generate massive amounts of cash flow. In fiscal 2016, Cisco generated $12.4 billion of free cash flow, an increase of 10% from the previous year.
Cisco ended fiscal 2016 with a $4.6 billion project backlog, which should help support future growth. Analysts expect the company to grow EPS by 1.6% in fiscal 2017.
This doesn’t sound like much, but it would be more than enough growth for Cisco to raise its dividend by 10%.
Dividend analysis
Cisco’s growth slowed in 2016, and EPS is expected to just inch higher in 2017. Ordinarily, this would raise doubts as to how much the company will raise its dividend.
But Cisco is no ordinary company.
Despite a growth slowdown, Cisco remains highly profitable and generates huge amounts of cash flow. As such, it has a modest dividend payout ratio.
In the past 12 months, Cisco posted EPS of $2.09. Its current annualized dividend totals $1.04 per share.
This results in a payout ratio of 50%, which means the company distributes only half of its EPS to investors.
There is plenty of room to increase the dividend by 10% and still not jeopardize the sustainability of its payout.
For example, even if Cisco were to post flat EPS in fiscal 2017, a 10% dividend increase would only raise the payout ratio to 55%.
In addition, Cisco has an added advantage in the form of a rock-solid balance sheet. Cisco benefits from tremendous free cash flow, combined with a modest amount of debt—and all that cash has really piled up.
Cisco ended last quarter with $70 billion of cash and marketable securities on its balance sheet. Meanwhile, it has $30 billion of long-term debt.
Cisco’s cash represents approximately 47% of its current market capitalization, meaning the company is very adequately capitalized. It is aggressively deploying this cash to return capital to shareholders.
Source: 2016 Annual Report, page 6
Over the past few years, Cisco has significantly lowered its share count and simultaneously increased its dividend at a high rate.
Final thoughts
Cisco has a 3.6% dividend yield and has increased its dividend by high rates over the past few years. For example, its 2016 dividend hike was a very healthy 24%.
Cisco may not go that high in 2017, due to the slowdown in routers and switching and the necessary investments to fuel stronger growth rates.
But it still generates huge amounts of cash flow, and has a balance sheet stuffed with cash. As a result, shareholders can reasonably expect a 10% dividend increase in February.
Disclosure: I am not long any of the stocks mentioned in this article.
Start a free seven-day trial of Premium Membership to GuruFocus.Ă‚
