Cisco’s Outlook Sinks Stock But Approaching Deep Value Territory

by Trefis Team
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Cisco (NASDAQ:CSCO) announced solid Q3 FY 2012 results on Wednesday, as revenues grew 7% and profits 21% over the same period last year. This was in sharp contrast to the revenue downturns that two of its biggest rivals, Alcatel-Lucent (NYSE:ALU) and Juniper Networks (NYSE:JNPR), suffered in their most recent quarters. However, Cisco’s shares slumped to their lowest in more than six months, falling almost 9% in post-market trading as the company guided for a slow next quarter and warned that technology spending could take a hit in the coming months. The company CEO, John Chambers, attributed the grim outlook to the macro-economic uncertainty surrounding the European debt crisis that is causing customers to remain cautious in their capital spending.

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Cisco deeply undervalued…

While Cisco has so far managed the uncertainty well by keeping its expenses low, thanks to a restructuring initiative, the markets are concerned that a deepening of the crisis in Europe would have a telling effect on the company’s business. However, with the company getting refocused on its core businesses and driving efficiency in its operations, we believe that it is being deeply undervalued at its current market price. We maintain our price estimate of $23.40 for Cisco, as our model already takes into account the aforementioned concerns together with the company’s long-term plan of achieving stable operating margins in the mid-20s. Following the post-earnings sell-off, our price estimate is about 35% ahead of the current market price.

In our earnings preview, we had talked about how there is a need to maintain a conservative view of the company given the global macro-economic concerns in the near-term. However, we also believe that the longer term outlook for Cisco looks strong not only due to an industry-wide change of fortunes once the uncertainty eases but also the company’s bigger market share within the industry. The company’s strong market position has helped it outperform rivals Juniper and Alcatel-Lucent in an uncertain economic environment so far, and will help it even further when the concerns subside.

As margins stabilize

The fact that Cisco is also focused on driving its operating margins up and increasing profits at a rate faster than revenues bodes well for the company. The results showed that the organizational restructuring that Cisco has undergone in order to reduce costs while increasing focus on core businesses is paying off. The operating margins that were fluctuating widely as a result of the restructuring are stabilizing, as the company reported its second consecutive quarter of solid operating margin of around 24% after fluctuating between a low of 13% and a high of 24% in the recent past. 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 from hereon.

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