Cisco Looks Like A $23 Stock Heading Into Earnings

Many eyes will be on Cisco (NASDAQ:CSCO) August 15th as the networking giant, widely used as a barometer to judge the state of the broader IT sector, announces its final quarter earnings for FY 2012. The macroeconomic uncertainty surrounding the Euro debt crisis has forced businesses to cut spending on network infrastructure, in turn affecting the revenues and profits of most networking companies including Alcatel-Lucent (NYSE:ALU) and Juniper Networks (NYSE:JNPR). Comparatively, however, Cisco has managed to hold its own, growing its revenues at a healthy clip y-o-y over the past few quarters and restructuring its operations to increase focus on a few core areas.

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Strengthening margins

The company announced last year that it had decided to scale back its ambitions of diversifying into 30 new businesses and will instead focus on those areas that add value to its core routing and switching businesses. As a result, it has restructured its operations and continues to cut jobs in areas that are not its core focus, making the organization leaner and more efficient. As recently as last month, the company announced that it would be laying off about 1300 employees in what seems to be the final stage of restructuring.

The cost cutting and restructuring seems to be paying off for the company which saw its operating margins stabilize at 24% last quarter, after fluctuating between a low of 13% and a high of 24% in the recent past. This increases confidence in the management’s guidance of achieving a long-term operating margins in the mid-20s and increasing profits at a faster pace than revenues. As of last quarter, Cisco had already realized $945 million of the total $1 billion of severance charges related to the workforce reduction program it had announced in July 2011, and we believe the operating margins will remain stable from hereon.

Solid Fundamentals

As for top-line growth, we believe Cisco’s fundamentals remain solid due to the burgeoning usage of data on both mobile and wired networks as well as a strong demand for cloud-computing solutions on the enterprise side. The company recently debuted its virtual cloud-routing and WAN optimization platform under the Cisco Cloud Connected Solution brand to enable businesses that are increasingly looking to move their applications to the cloud at a low cost. (see Cisco’s Worth $23 On Cloud Foray And Enterprise Strength) Its recent move to acquire NDS Corp was made to drive device-agnostic video consumption and increase the demand for its routers and switches among service providers that are looking to monetize the booming demand. (see Cisco’s NDS Acquisition Taps Video Demand To Boost Network Equipment Business)

Both these moves show that the company’s restructuring and turnaround efforts have helped it streamline its businesses around its core networking products that contribute almost 35% to our estimated $23 fair value for Cisco, with cash contributing another 25%. While the macro-economic environment may continue to be challenging (and the company may also issue a similar guidance for the future), we believe that Cisco has executed well on its turnaround plans so far and is well-positioned with its new-found focus to gain even higher ground going forward. The company’s dominant market position has helped it outperform rivals Juniper and Alcatel-Lucent in an uncertain economic environment so far, and could help it even further when the concerns subside. (see Cisco’s Post-Earnings Crash Makes The Stock Look Incredibly Cheap)

In anticipation of the earnings announcement, Cisco’s stock has moved up more than 10% in the past week and our price estimate is about 30% ahead of the market price currently.

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