Cisco on Right Route to Enhancing Value

Shares of Cisco have traded off a bit in the past couple days on concerns the company was going to announce a big employee downsizing program of 9,000 to 14,000 jobs. A restructuring of this magnitude usually represents coming troubles at an organization. Cisco reported better-than-expected earnings after the closing bell on Wednesday, Aug. 12. Earnings per share were three cents better than expected at 63 cents while revenues were also a bit ahead of expectations. Management also guided to a good coming quarter, although the low end of the EPS range -- 58 cents to 60 cents -- was below the pre-call consensus of 60 cents per share. Investors' fears of a cataclysmic restructuring did not come true, although the company did announce 5,500-job employment reduction program, which would equal about 7% of the employee base. While unfortunate, a headcount reduction of this magnitude to reposition the company is quite acceptable. It shows management is moving resources to higher-value areas, which executives fully explained during the call. Getting to the quarter, the numbers were better than expected, with revenues up 2% year over year on strong sales in Security, which was up 16%; Collaboration, up 6%; Wireless, up 6%; and Switching, up 6%. Sales to emerging markets and telecom services providers were down. Routing had a particularly poor quarter, with sales down 6%. Management gave good but conservative guidance for the coming quarter; a recurring theme of relatively muted sales guidance was reiterated due to weak order growth of 1%. Many of the emerging markets -- in particular China, with orders down 12% -- will be weighing on top-line growth. Fortunately, the new technologies have been offsetting emerging market weakness. Moreover, Cisco has been able to offset the top-line slowdown through margin enhancements. Gross margins rose to 64.6% during the quarter -- 70 basis points better than anticipated -- through a positive mix shift to newer software-based technologies and good old-fashioned cost-cutting programs. Operating margins were also better due to sales, general and administrative (SG&A) savings programs. Even amid a slow top-line environment, the company was still able to generate 7% growth. We expect these trends to continue to play out this way all through the next year. The macro environment is still sluggish due to cautious business spending and weak emerging-market demand. However, Cisco has a steady playbook to grind out both top- and bottom-line results through technological innovations, cost cutting and further international expansion. In the meantime, we expect the company to continue to reward shareholders through a generous dividend -- current yield of 3.44% -- and an aggressive share repurchase program that has been shrinking the share base by 1% to 3% per year. We like the new CEO, Chuck Robbins, who is doing a good job running the company as well as communicating with the investment community. We believe he has a strong commitment to enhancing shareholder value and in meeting or exceeding his stated business objective. We think this new leadership should be another factor in accelerating the company's progress and should help with expansion of Cisco's multiple. The shares are inexpensive and trading at about 12.5x the 2017 EPS estimate of $2.43.When you adjust for CSCO's $37 billion of net cash, which is equal to about $7.35 per share, you get a 9.3x price/earnings multiple. The shares are a great value by any measure and we would be adding to them at current prices.

Cisco on Right Route to Enhancing Value

New leadership should help accelerate the company's progress and expansion of its multiple.

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