Cisco’s (NASDAQ:CSCO) shares have tumbled since it announced its Q3 FY 2012 results last week. While the networking giant saw solid growth in revenues and an even stronger growth in profits for the quarter ended April, the markets were unforgiving toward the company’s mellowed guidance for the next quarter.
Cisco’s shares dropped almost 9% following the earnings on Wednesday and haven’t showed much much life since. However, we believe the markets are being overly pessimistic here, thereby offering significant value for a large-cap company that is executing pretty well on its turnaround plans so far.
We have a price estimate of $23.40 for Cisco, which is almost 40% ahead of the current market price.
Cisco deeply undervalued…
Our major concern going into the earnings was Cisco’s ability to continue executing effectively on its turnaround plans in a tough economic environment. The earnings report, we believe, alleviated those concerns to a great extent as the company managed to keep its expenses low, thereby growing its net profits by 21% over the same period last year.
The results reaffirmed our view that the turnaround at Cisco is well underway, with the organizational restructuring the company underwent to reduce costs paying off. The operating margins that were fluctuating widely as a result of restructuring are now stabilizing as the company reported its second consecutive quarter of solid operating margin of around 24%. With $945 million of the total $1 billion of severance charges related to the workforce reduction program announced in July 2011 already realized, we believe that the operating margins will remain stable hereon.
However, the markets chose to fixate on its guidance for the final fiscal quarter despite Cisco continually issuing similar warnings in the past as well. Sure, a deepening of the European debt crisis could have an impact on its business, but the company’s increased focus on its core businesses while driving operational efficiency should help it weather that storm reasonably well and come out even stronger. Moreover, the demand for data services is exploding, and we believe Cisco is well positioned with its high market share to take advantage in the longer term.
1/3 of Cisco’s value is net cash
How undervalued the company currently is can be gauged from the fact that more than 1/3 of its current market capitalization is cash, net of debt.
This could act as cushion in the event of an economic slowdown while also allowing it to invest in companies such as ClearAccess and NDS Group and position itself well when the uncertainty subsides. (see Cisco’s ClearAccess Deal Could Breathe New Life Into Routers Business) Moreover, Cisco has been generating huge positive cash flows in the order of billions from operations every quarter despite a challenging economic environment.
We believe that the company will continue to execute well on its turnaround plans, banking on a leaner structure to grow its profits at a rate higher than revenues. A positive cash flow will ensure that the company is able to return cash to shareholders through regular dividends and share repurchases.