Cisco: Not the Best Idea in Big Cap Tech
publication date: Aug 14, 2014
author/source: Brian Nelson, CFA
It’s hard not to like Cisco’s (CSCO) strong free cash flow generation, solid cash balance, and dominance in the communications networking market, but fiscal fourth-quarter results (ended July 26), released Wednesday after the close, weren’t great. We continue to prefer Apple (AAPL) in the Best Ideas portfolio and Microsoft (MSFT) in the Dividend Growth portfolio as the large cap technology exposure, among others.
The Best Ideas portfolio seeks to find firms that have good value and good momentum characteristics and typically holds each idea from a Valuentum Buying Index rating of a 9 or 10 (consider buying) to a rating of a 1 or 2 (consider selling). The goal of the Best Ideas portfolio is to generate a positive return each year and to exceed the performance of a broad market benchmark.
The Dividend Growth portfolio seeks to find underpriced dividend growth gems that generate phenomenal levels of cash flow and have pristine, fortress balance sheets, translating into excellent Valuentum Dividend Cushion scores. The goal of the Dividend Growth portfolio is to generate a mid-to-high single digit annual return over rolling three-to-five year periods.
Cisco’s CEO John Chambers is not pulling the wool over anyone’s eyes: Cisco is making the best out of a difficult situation. Revenue was flat on a year-over-year basis in the quarter, while earnings per share also came in roughly flat. GAAP net income dropped from the year-ago period, but the firm managed to post its best non-GAAP earnings-per-share quarter in history (mostly because of aggressive share buybacks). Cisco continues to generate gobs of free cash flow ($3.3 billion in the quarter), but the market environment certainly remains a difficult one, especially in emerging markets:
-- Fiscal year 2014 was a year with many big wins and several challenges. Our fiscal year began with the number of external headwinds including the federal government shutdown and the possibility of a U.S. default combined with significant slowdown in emerging markets.
Asia Pacific, Japan and China was down 7% with China down 23% and India up 18% while the remaining emerging countries in Asia actually declined 34%. Those are countries that did not include China and India. Overall emerging countries within the three geographies declined this quarter by 9%. We saw the impact of economic and geopolitical challenges in China, Brazil, Russia, Argentina, Turkey, and Thailand and in a number of emerging markets that many of other peers are seeing. These declines are reducing our growth by several points from what was expected and typically seen.
Though the trends were looking better in Q2 and Q3 for emerging markets, the emerging countries lost momentum in Q4, the breakdown continued in double-digit declines and the next 15 emerging countries went from positive growth to mid-single-digits in Q2 and Q3 to a 9% decline in Q4. Unfortunately as we look out we don’t see emerging markets growth returning for several quarters and believe it possibly could get worst. -- conference call
The communications networking giant said revenue would be flat to up 1% on a year-over-year basis during the current quarter and non-GAAP earnings-per-share in the range of $0.51-$0.53 per share (the midpoint slightly lower than consensus estimates). In the coming months, Cisco will slash 6,000 jobs to help meet its bottom-line targets, a reduction of roughly 8% of its workforce. Unlike Microsoft which is purging itself of overlap from its acquisition of Nokia’s (NOK) Devices and Services operations in its decision to cut 18,000 jobs, the job cuts at Cisco are starting to get to the bone. According to Bloomberg, the company has shed nearly 26,000 positions since February 2009 (its current workforce is ~74,000).
We continue to believe investors should keep Cisco on their watch list, especially those with income-orientation. Shares yield 3.1% at the time of this writing, and while we believe the company’s dividend is rock-solid (and poised for future growth), investors might get a better entry point in shares yet. Massive layoffs and the probability of emerging market revenue getting worse are two major red flags at the company. Our best ideas are included in the Best Ideas portfolio and Dividend Growth portfolio.
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