Cisco Systems Inc. (CSCO, Financial) was off to a good start heading into 2017, but the growing concerns around its core business continue to hurt the stock. The stock is up just 1% year to date, down 11% from its 52-week high.
Considering the growth outlook for software-centered solutions, Cisco is transitioning from a hardware-centered strategy toward software, which will help it to compete effectively against cheaper rivals in the years ahead.
Cisco reported disappointing fourth-quarter results after the market closed on Aug. 16. Shares of Cisco plunged more than 4% the day after. For the quarter ended in July, the company logged earnings per share of 61 cents, in line with the estimates.
Revenue came in at $12.13 billion, beating the consensus by $60 million but declining 4% year over year. The company’s revenue declined for the seventh consecutive quarter, which has forced shareholders to question whether it will be able to return to positive revenue growth in the near future.
Cisco generates the majority of its revenue from selling data center switching and routing hardware. In the previous quarter, revenue from its core business totaled $5.3 billion, representing a drop of 9% year over year. The primary reason for this decline is growing competition from cheaper rivals like Juniper Networks (JNPR, Financial) and Arista Networks (ANET, Financial).
On the other hand, the company’s service revenue was $3.1 billion, a surge of 1% year over year. Revenue from subscriptions now account for more than 50% of the company’s software revenue. Moreover, its operating margin was strong at 31.5%. For the full year, its overall gross margin was 64.3%, a drop of just 0.4 points.
Cisco recently announced it completed the acquisition of Viptela Inc., a software-defined wide area network (SD-WAN) company, which will help grow its SD-WAN portfolio with improved flexibility and simplicity delivered through the cloud.
Cisco is also aggressively focusing on expanding its footprint in the cybersecurity space. In July, the company revealed it plans to acquire security startup Observable Networks, which sells its security service as a subscription.Â
Despite a slowing core business, Cisco’s free cash flow continues to grow at a healthy rate. The company closed the fourth quarter with free cash flow of $3.8 billion, up 7% year over year. The most significant thing attracting investors is Cisco’s forward dividend yield of 3.75%. In the prior quarter, the company returned $2.6 billion to shareholders through a share repurchase program and a quarterly dividend.
Cisco guided for an unpleasant first quarter of fiscal 2018. For the quarter, it expects earnings per share between 59 cents and 61 cents on 1% to 3% less revenue compared to a year ago.
Summing up
Cisco continues facing fierce competition from cheaper rivals. To overcome this issue, the company is transitioning toward software-based solutions which will help it to grow well in the future. The company is also aggressively focusing on the cybersecurity market, which is projected to grow at a strong rate.
Despite offering a robust dividend yield, its payout ratio currently sits at 52.3%, suggesting it still has a lot of room to increase its dividend in the future. Moreover, it has robust free cash flow, which will help it pay its dividend and give it flexibility to find new sources of growth. The stock currently trades at a price-earnings (P/E) ratio of 15, making it undervalued.
As a result, investors should consider adding Cisco to their portfolios at the current market price as it is down 11% from its 52-week high.
Disclosure: No position in the stocks mentioned in this article.
