Many eyes will be on Cisco (NASDAQ:CSCO) November 13th as the networking giant, widely used as a barometer to judge the state of the broader IT sector, announces its first quarter earnings for FY 2013. 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). Cisco, which draws almost 20% of its revenues from Europe, is not immune to the impact of the spending cutbacks either. Comparatively, however, the company has managed to hold its own so far, growing its revenues at a healthy clip y-o-y over the past few quarters and restructuring its operations to squeeze out profits at a faster pace while increasing focus on a few core areas.
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Cisco 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. At the same time, it is bolstering its networking businesses in high growth markets through strategic job hires. The company added 1,400 employees last quarter, half of which were recruited in emerging markets. This came on the back of the 1,300 job cuts that were announced in July.
We believe that the company is going in the right direction since its core networking products contribute almost 41% to our estimated $26.50 fair value for Cisco. The cost cutting and restructuring seems to be paying off as the company is seeing its operating margins stabilize at >20% levels, after having fluctuated widely in recent quarters. 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. Cisco has already realized $1 billion of the total $1.1 billion of severance charges related to the workforce reduction program it had announced in July 2011, and the operating margins should remain fairly stable from hereon. With savings achieved on the operating side, Cisco will be able to make aggressive price cuts to compete better with low-cost rivals such as Huawei and gain even more market share.
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)
Cisco also has tons of cash – more than a third of its current market capitalization. It has been generating huge positive cash flows in the order of billions from operations every quarter despite a challenging economic environment. A positive cash flow ensures that the company will able to return cash to shareholders through regular dividends and share repurchases as well as make strategic acquisitions.
While the macro-economic environment may continue to be challenging (the company remains cautious in its guidance for the future) in the near-term, 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. (see Cisco’s Post-Earnings Crash Makes The Stock Look Incredibly Cheap) The company’s dominant market position as well as aggressive price cuts have helped it gain market share from rivals in an uncertain economic environment so far, and could help it even further when the concerns subside.