Cisco
shares look flat-out cheap. The networking equipment giant’s stock has been a laggard in 2023, with a 15% gain on the year, versus the
Nasdaq Composite’s
27% rally. The stock trades for less than 14 times forward earnings and under four times forward sales. And that for a company that offers a nearly 3% dividend yield and is aggressively buying back stock.
But the Cisco Systems (ticker: CSCO) story is a complicated one, with a recent business dynamic that can be dizzying to untangle. Cisco sales crumbled in 2020, as the work-from-home trend crushed demand for enterprise hardware, while component shortages reduced the company’s ability to fulfill the orders it had. In 2021, as businesses started spending again, orders piled up—topping 30% growth for three straight quarters. Cisco continued to grapple with parts shortages, though, and its backlog ballooned.
Over the past few quarters, the dynamic has reversed. The component shortages are gone, which has allowed Cisco to speed up shipments, providing a boost to revenue. On the other hand, as product lead times normalized, orders slowed sharply. The bearish case has been that once Cisco whittles down its backlog, growth will slow, putting Cisco at the mercy of tightening IT budgets. No one seems certain what Cisco’s normalized long-term growth might be.
You can see the issue playing out in Cisco’s results reported this past week. Revenue for the July quarter was up 16% from a year earlier, the company’s best quarterly growth since 2010. Orders were down 14% from a year ago, but up 30% from the April quarter, about 10 percentage points better than the historical average sequential increase. The year-over-year order decline was still better than Wall Street estimates, and it was closer to 10% once you back out the telecom segment, which has been aggressively curtailing spending, as evidenced by recent weak results from
Nokia,
Ericsson,
and
Juniper Networks.
One wrinkle: Cisco said that revenue for its July 2024 fiscal year would be up just 1%, a point or two below Wall Street estimates. That includes an expected 7% increase in the current fiscal first quarter, which implies a revenue decline in the back half of the year.
But this is what Meta CEO Mark Zuckerberg has described as “the year of efficiency,” and Cisco CEO Chuck Robbins has gotten the message. Adjusted gross margin in the latest quarter was 65.9%, up 2.6 percentage points from a year earlier. Robbins says Cisco will boost profits faster than revenue, as it maintains a tight grip on costs.
The company plans to keep buying back stock, at about a $5 billion annual rate to go along with its rich dividend payout.
While Cisco shares waffled in late trading on Wednesday following the earnings report, investors eventually saw the results as good news. Shares closed up 3.3% on Thursday despite a tough day for tech stocks.
One other clear piece of good news: Cisco said that it has had more than $500 million in orders to date for hardware targeted at generative AI-related data centers. Cisco Chief Financial Officer Scott Herren told me that AI-related business will meaningfully show up in the company’s financial results by the end of fiscal 2024 and into fiscal 2025. “We see a multiyear opportunity ahead, and we are well positioned to win in that space,” he said.
The bottom line: Cisco is driving higher margins and profit growth even with flattish sales—and we’re not too far out from a material kick to the top line as cloud companies buy up networking gear to support the growing demand for generative AI computing. If Wall Street decides to start viewing Cisco as an AI play, the stock could get on a roll.
Write to Eric J. Savitz at eric.savitz@barrons.com
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