Cisco Stock Looks Undervalued Given Increasing Software Focus, Solid Cash Position

by Trefis Team
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Cisco’s (NASDAQ: CSCO) stock has lost a sizable chunk of its value since the middle of 2019 with the company’s share price shrinking from over $58 in mid July to around $44 now. Weak earnings figures for Q1 2020 (ending October 2019) as well as soft full-year guidance also weighed on the company’s share price over recent weeks. However, we believe that the company’s stock is currently undervalued and estimate Cisco’s valuation to be $52 per share – roughly 15% ahead of the current market price. Our price estimate takes into account the latest earnings as well as the company’s guidance.

Cisco’s total revenue increased 1% (y-o-y) to $13.2 billion in Q1 2020, with product revenue up 1% and service revenue up 4%. The gross profit rate increased by 170 basis points to 65.9% while adjusted net income increased by nearly 5% to 3.6 billion or $0.84 per share. Notably, at the end of Q1 2020, 71% of Cisco’s software revenue came from subscription and SaaS versus the company’s target of 66% by the end of 2020.

Below we provide a detailed explanation of the key factors that could impact the company’s valuation:

Cisco Is Transitioning Towards A Software-Focused Business Model

  • Cisco is changing from a hardware product-focused company to a software-based one. The company’s focus is to sell more software and subscription-based offerings which have a higher margin than its traditional hardware product offerings.
  • Cisco is beginning to reap the benefits of this transition, with the company’s operating margin expanding from less than 40% in 2017 to more than 43% in 2019.
  • Moreover, the transition is also helping the company to develop a more stable revenue stream as the software subscriptions are generally renewed every three to five years.
  • Cisco remains on course to achieve its FY’20 objective of generating respectively 30% and 50% of total revenues from its Software and Services businesses.

Infrastructure Platforms Is The Core Of Cisco’s Business Model

  • Infrastructure Platforms is Cisco’s largest segment consistently accounting for nearly 60% of the company’s revenues.
  • The segment has added nearly $2.5 billion to Cisco’s total revenues since 2016, accounting for nearly two-thirds of the company’s incremental revenue growth, led by a steady increase across the switching and routing portfolio partially offset by weakness in the service provider market.
  • We expect the segment to continue its steady growth and record just shy of $31 billion in revenues in FY 2020 likely to be led by growth from wireless products driven by increases across the portfolio.

Cisco Has A Solid Cash Position

  • Cisco ended FY 2019 with more than $11 billion in cash and reported operating cash flows of nearly $16 billion. Cisco’s strong cash flow position coupled with its strong cash conversion ability gives the company considerably leeway in its capital allocation strategy.
  • Notably, Cisco’s dividend payments have increased in each of the last five years and the company’s share count has declined from more than 5 billion in 2015 to less than 4.5 billion in 2019.
  • Moreover, the management intends to return a minimum of 50% of its free cash flow annually to its shareholders through cash dividends and repurchases of common stock which is likely to boost Cisco’s valuation going forward.

Per Trefis estimates, Cisco’s adjusted EPS for 2020 is likely to be $3.23. Taken together with a P/E multiple of 16.2x, this works to a fair value of $52 for Cisco’s Stock which is roughly 15% ahead of the current market price.

We highlight how Cisco’s P/E multiple has trended over the years, and compare this key metric with that for its peers Juniper, HPE, and F5 Network in our interactive dashboard.


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