Cisco Earnings Preview: Currency Headwinds May Offset Better Carrier Spending

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Cisco (NASDAQ:CSCO) is scheduled to release its Q2 fiscal 2016 (ended January) earnings on Wednesday, February 10th. While the company managed to surpass market expectations with its Q1 results, its guidance for the recently concluded quarter wasn’t promising. Citing macroeconomic uncertainty leading to weak order growth and currency headwinds as the main reasons, Cisco stated at the end of Q1 that it expects flat revenue and non-GAAP EPS growth (year-over-year) for the second quarter of fiscal 2016. However, its performance should improve in subsequent quarters as its deferred revenues grew strongly during the first quarter. [1] Additionally, there have been several developments over the past few months that indicate a bright future for the company, including a long-term alliance with Ericsson (NASDAQ:ERIC) and the Jasper acquisition.

However, from a short-term perspective, Cisco is reliant on U.S. carriers’ spending for a bulk of its growth given that it earns a major share of its revenues from service providers, and more than half of its revenues come from the Americas. Fortunately for Cisco, carriers – especially Verizon and AT&T – have been relatively liberal with their spending during the quarter ended December, which bodes well for Cisco. On the company-specific front, Cisco has seen notable improvement in its routing division on account of new product launches. This likely helped it realize better sales during the second quarter of fiscal 2016.

We have a $26 price estimate for Cisco, implying a 20% premium to the current market price

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Increased Carrier Spending May Have Helped Cisco

Cisco is part of an ecosystem that depends on carriers’ capital spending for its revenues. U.S. carrier spending had been a little sluggish for the past few years due to macroeconomic weakness and fierce competition. While economic weakness was resulting in weak 4G demand, competitive pricing was preventing companies from improving revenue generated per 4G subscriber. This discouraged telcos from spending too much on network upgrades and expansion, and incentivized them to focus on increasing productivity instead. This ultimately impacted revenues for the entire networking ecosystem. However, during the quarter ended December 2015, Verizon and AT&T upped their capital spending significantly, which means that Cisco would have had an opportunity to improve its Q2 fiscal 2016 top line growth. Verizon’s wireless and wireline capital expenditures were up 20% and 5% (y-o-y), respectively, and AT&T’s capex was up 34%. [2] While this would have had a positive impact on Cisco’s revenues within the U.S., the strong dollar likely suppressed its revenues coming from outside the U.S.

Routing Sales Could Improve

Cisco’s routing sales increased just 1% last fiscal year due to growing competition from white label hardware. During the first quarter of the current fiscal year, the division’s sales fell an alarming 8% to $1.8 billion, which the company mainly attributed to the timing of the large deals in Q1. However, it mentioned that order growth was solid, as orders for newly introduced routing platforms were up in triple digits. We believe that a portion of these orders would have materialized in the recently concluded quarter, which should help Cisco post solid results for its routing division. During its last quarter earnings call, the company even announced that it had a few routing launches lined up for Q2, which should have also contributed to the segment’s growth. [1]

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Notes:
  1. Cisco’s Q1 Fiscal 2016 Earnings Transcript, Nov 12 2015 [] []
  2. Companies’ SEC filings []