With Product Sales Sluggish, What To Expect From Cisco’s Q3 Earnings?

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Cisco Systems Inc (NASDAQ: CSCO) is poised to report its Q3 FY’24 results on May 14, reporting on a quarter that is likely to see the company’s sales contract, as customers focus on deploying hardware inventory purchased in the recent quarters.  We expect revenue for the quarter to come in at about $12.8 billion, coming in slightly ahead of estimates although this would mark a 14% decline compared to last year. We project that earnings will stand at about $0.84 per share, coming in marginally ahead of consensus estimates. So what are some of the trends that are likely to drive the company’s results for the quarter? See our analysis of Cisco Earnings Preview for more details.

Cisco’s product sales have seen a slowdown as the company’s customers have been focused on installing and implementing the products purchased over the last few quarters. This is likely to impact revenue for Q3 as well, as excess inventory is absorbed by customers. Moreover, large companies, including cloud service providers and telecommunication players, have been holding back on networking spending amid some economic uncertainty.  Separately, Cisco is also facing competition from smaller networking companies and this is also impacting growth. Over Q2 FY’24, Cisco’s product revenue declined by 9%. However, Cisco is seeing a higher mix of service sales and software subscriptions. Over the last quarter service revenue rose by 4%.

On the margins front, Cisco has been making progress with overall gross margins in recent quarters, led by lower freight and component costs, a favorable product mix, and overall better cost management. Over Q2 FY’24, gross margins rose to 66.7% up 280 basis points compared to the year-ago period. Cisco has been increasingly pushing toward a recurring revenue model with its software subscriptions and services contracts, and we will be tracking the company’s performance on this front. Over the last quarter, total annualized recurring revenue stood at $24.7 billion, up 6% year over year. The company expects this metric to grow by another $4 billion, following the closure of its acquisition of Splunk.

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CSCO stock has witnessed gains of 10% from levels of $45 in early January 2021 to around $50 now, vs. an increase of about 35% for the S&P 500 over this roughly 3-year period. However, the increase in CSCO stock has been far from consistent. Returns for the stock were 42% in 2021, -25% in 2022, and 6% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that CSCO underperformed the S&P in 2022 and 2023. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Information Technology sector including MSFT, AAPL, and NVDA, and even for the mega-cap stars GOOG, TSLA, and AMZN. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could CSCO face a similar situation as it did in 2022 and 2023 and underperform the S&P over the next 12 months – or will it see a strong jump?

We believe CSCO stock is somewhat undervalued at current levels. The stock trades at just about 14x consensus earnings for FY’24. We think this is a reasonable valuation, even though growth for this year is likely to be muted. Cisco’s push into the recurring revenue model and its increasing focus on cybersecurity, via acquisitions, could help the stock. We also believe that the company will perform better than its big tech peers in the event of a potential economic downturn given the secular spending trends on digitization and networking.  We value CSCO stock at about $55 per share, which is about 15% ahead of the current market price. See our analysis of Cisco Valuation for a closer look at what’s driving our price estimate for the stock. Also, check out our analysis of Cisco Revenue for more details on the company’s key revenue streams.

 Returns Apr 2024
MTD [1]
2024
YTD [1]
2017-24
Total [2]
 CSCO Return -4% -5% 58%
 S&P 500 Return -3% 7% 128%
 Trefis Reinforced Value Portfolio -5% 2% 622%

[1] Returns as of 4/27/2024
[2] Cumulative total returns since the end of 2016

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