Cisco’s Dancing Margins Will Be The Focus Of Earnings On Wednesday

Cisco (NASDAQ:CSCO) is set to report its third quarter earnings of fiscal 2012 on Wednesday. While competitors  Alcatel-Lucent (NYSE:ALU) and Juniper Networks (NYSE:JNPR) continue to reel under the macro-economic uncertainty which has forced enterprises to cut spending on network infrastructure, Cisco has managed to hold its own. The company’s revenues have grown at a healthy rate y-o-y over the past four quarters and even managed to beat analyst expectations last quarter. However, while gross margins have remained fairly stable, operating margins have fluctuated as the company underwent a restructuring in order to focus on key areas.

During the earnings call, we will be closely watching the company’s operating margins which rose to the highest in the past year. As margins stabilize, we could see the stock get a much needed boost. Our Trefis price estimate for Cisco stands at $23.37, which is about 20% ahead of the current market price.

See our full analysis on Cisco

Uncertain Economic Environment

Cisco’s revenues have increased at a healthy rate q-o-q as well as y-o-y over the past four quarters. In Q2 FY 2012, Cisco’s revenues grew close to 11% over the same period last year despite the continued impact of macroeconomic uncertainty on government, enterprise as well as service provider spending in both the U.S. and Europe. As a result of the restructuring it undertook to increase focus on distinct core areas, Cisco has been performing better than most competitors in the recent quarters. However, macroeconomic concerns due to the ongoing Euro zone debt crisis remain and it is therefore prudent to keep a check on expectations and maintain a conservative view, at least until the uncertainty eases.

Cisco expects its revenue for the third quarter to increase 5% to 7% on a year-over-year basis.

Operating Margins Key

Cisco’s gross margins have been pretty stable in recent quarters. The company had gross margins of 61.3%, 61.2%, 61.3% and 61.3% during the past four quarters. Cisco’s operating margins, on the other hand, have fluctuated widely. The company reported operating margins of 23.7%, 19.6%, 13.1%, 20.1% and 16.2% during the past five quarters. The swings have mostly been due to the restructuring that the company has undergone resulting in many one-time charges that have had an irregular impact on margins.

Last quarter saw the operating margins improve sequentially for the second consecutive quarter. A further improvement or a stabilization of margins here should boost the stock. However, a decline in margins will see uncertainty return and the stock could take a beating as a result.

Cisco seems to be focused on improving its margins and will be realizing less than $100 million of restructuring charges in the first two quarters of 2012, having already realized $925 million of the total $1 billion of severance charges related to its workforce reduction program announced in July 2011. ((Cisco Systems’ CEO Discusses Q2 2012 Results – Earnings Call Transcript))

Understand How a Company’s Products Impact its Stock Price at Trefis