Cisco Systems, Inc. (NASDAQ:CSCO) is a company that many people have written off as “dead money.” With a range-bound stock price over the past decade amidst slow but steady earnings growth, Cisco hasn’t exactly been an exciting stock. But often the least exciting stocks offer the most exciting opportunities, and over the past year the stock offered multiple chances to buy at an insanely low price.
A few days ago Cisco Systems, Inc. (NASDAQ:CSCO) reported its Q3 earnings, and given the 12% spike in the stock price the next day it seems that people may finally be waking up and realizing that Cisco may not be dead money after all. The stock hit $24 per share intra-day, levels not seen since 2010 and a full 60% higher than the 52-week low. Is Cisco stock still a good buy?
Slow and steady wins the race
Cisco Systems, Inc. (NASDAQ:CSCO) beat analyst expectations in Q3, with revenue growing 5.4% year-over-year to $12.2 billion and non-GAAP EPS growing 6.3% to $0.51. With worries about the state of the global economy and threats against Cisco’s core switch business, the company showed that its business is more robust than some assumed. CEO John Chambers had this to say:
Cisco is executing at a very high level in a slow, but steady economic environment. We are especially pleased with our ninth consecutive record revenue quarter. We are starting to see some good signs in the US and other parts of the world which are encouraging. We have the right products, the right solutions and our customers are coming to us to solve their biggest business problems. The pace of change is increasing and Cisco is well positioned.
Massive growth in some divisions
While Cisco Systems, Inc. (NASDAQ:CSCO)’s core switching market saw year-over-year revenue decline by 2% there were some divisions that showed exceptional growth. The data center division grew revenue by a whopping 77% year-over-year, surpassing the $500 million mark and making up about 4.2% of total revenue. The service provider video division grew revenue by 30%, bringing sales to $1.3 billion or 10.6% of total revenue. And the wireless division grew revenue by 27% to about the same levels as the data center division. Service revenue, which accounts for 21.7% of the total revenue, grew by 7%.
Cisco is not simply sitting back and allowing its core businesses to deteriorate. The company is growing non-core businesses rapidly, more than making up for the weakness in switching and routing.
Returning cash to shareholders
During the quarter Cisco Systems, Inc. (NASDAQ:CSCO) increased its pile of cash to $47.4 billion, or $31.1 billion net of debt. This works out to $5.78 per share in net cash, and provides Cisco the ability to buy back a tremendous number of shares. Over the past 12 months Cisco has spent a total of $3.4 billion on share repurchases, and since 2003 the diluted share count has been reduced by 25%. One thing to note is that some of this money went to offsetting the dilution caused by stock-based compensation, so the net reduction of shares outstanding was lower than it would have been otherwise.
In addition to the share repurchase program Cisco Systems, Inc. (NASDAQ:CSCO) began paying a dividend in 2011 and has since raised that dividend twice. The yield is about 2.85% after the big run up in the stock price after earnings, but it sat well above 3% prior to that. Cisco spent a total of $905 million on the dividend in Q3, and combined with the $860 million in share repurchases the company returned a total of $1.765 billion to shareholders during the quarter.
How much is Cisco worth?
During fiscal 2012 Cisco generated $10.365 billion in free cash flow. This works out to about $1.92 per share based on today’s diluted share count. I’ll do a simple discounted cash flow calculation, using discount rates of 12% and 15% to define a fair value range, to estimate the fair value of a share of Cisco. Assuming that the FCF grows by 6% annually for the next 10 years and by 3% annually after that, I arrive at a fair value range of $25.68 – $32.81 per share. Currently trading at around $24 per share Cisco is still below the lower bound of my fair value range even after the big run up.
Cisco’s moat is intact
Cisco sells the type of product that presents significant switching costs to its customers. This has allowed Cisco to maintain a massive market share in its core businesses even as it faces competition from companies like Juniper Networks, Inc. (NYSE:JNPR). And the company is spending heavily to gain market share in new areas, such as wide area networks, from companies like Riverbed Technology, Inc. (NASDAQ:RVBD). Cisco is about 10 times larger than Juniper and about 50 times larger than Riverbed in terms of revenue, and with far more resources available I’d bet on Cisco Systems, Inc. (NASDAQ:CSCO) every time over a smaller company. Cisco also has far better margins than either of these competitors, as can be seen below.
|Company||Operating margin||Net income margin|
On the one hand, companies like Juniper Networks, Inc. (NYSE:JNPR) and Riverbed Technology, Inc. (NASDAQ:RVBD) could grow to be much larger since the companies are so small today. But on the other hand, they’re competing with a behemoth with more money than it knows what to do with and a dominant share in many different markets. It seems like Cisco is the clear choice here.
The bottom line
Cisco Systems, Inc. (NASDAQ:CSCO) is still undervalued, but it seems that people have begun to realize this. With the stock surging by 12% on a slight earnings beat, the expectations were apparently quite low. Slow, steady growth coupled with share repurchases and an above average dividend makes Cisco a great stock to own.
The article Waking a Sleeping Giant originally appeared on Fool.com and is written by Timothy Green.
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