Cisco Systems: Surprisingly Resilient (NASDAQ:CSCO)

Late in 2021, I concluded that it was more of the same for Cisco Systems (NASDAQ:CSCO), as the company was continuing to pursue bolt-on deals in order to deliver on minimal revenue growth.

With (organic) revenue growth trailing the market, that was an indication that the business was underperforming, yet the balance sheet remained strong and valuations were non-demanding. Appeal had to come from a better operating performance, with few clues suggesting that was the case.

A Quick Recap

With exception to some excessive volatility around the dotcom crisis, Cisco has steadily grown its share price, albeit that it has traded range bound for many years as well, as momentum was quite strong ahead of the pandemic. Shares traded in the fifties at the time amidst steady growth and low risk-free rates pushing up earnings multiples.

The company has aggressively been pursuing bolt-on deals, although at times it was involved in some larger deals as well, including that of Acacia Communications. Shares fell during the pandemic but quickly recovered to trade around the $50 mark as the underlying business was hardly impacted by the pandemic.

For the fiscal year 2021, which ended in July of that year, Cisco actually posted a 1% increase in sales to $49.8 billion, with adjusted earnings pretty flat at $13.6 billion, a huge number. The company posted a $3.22 per share earnings number, albeit that GAAP earnings only came in at $2.50 per share. On top of this earnings power, Cisco actually held $13 billion in cash, equal to around $3 per share at the time.

With shares trading in the mid-fifties, the unleveraged business traded at 20 times GAAP earnings and 16 times adjusted earnings, as the company guided for 6% sales growth in 2020, with adjusted earnings seen between $3.38 and $3.45 per share. Following this guidance, shares were trading in the $50-$60 range in the second half of 2022, to even peak around $64 exactly a year ago. That should be seen in the light of a market environment in which major indices were peaking.

Given the valuations seen at the time I was a bit cautious. Valuations were reasonable, depending on which metric you look, while the balance sheet was solid and growth was reasonable, yet nothing too impressive. The company claims that a transition to more service like subscription features, as seen in an increasing backlog, should be a driver, yet investors had some doubts.

2022 – A Tough Year

With shares starting the year 2022 around their peak in the sixties, they have gradually come down amidst the wider technology sector, although they held up relatively well. Shares fell to just $40 in October, to rebounded to $47 at this point in time.

In August, it appeared that 2022 results were a bit weaker than guided for as full year sales rose just 3% to $51.6 billion, growing at half the pace originally predicted, amidst softer growth and some currency headwinds. This made that adjusted earnings of $3.36 per share came in a touch light as well, albeit that the gap with GAAP earnings narrowed as these earnings rose to $2.82 per share.

Troublesome is that no growth was seen in the final quarter (at least on a reported dollar basis), with earnings flattish, or actually down slightly. With a $0.45 per share adjustment made for stock-based compensation per year, the GAAP earnings appear to be a better indicator of real profitability than the adjusted metrics.

Net cash was down to $9.8 billion, mostly due to the combination of more share buybacks and dividends, still equal to nearly $2.50 per share. For the current fiscal year 2023, the company issued a rather upbeat guidance, calling for sales to grow between 4 and 6%, with non-GAAP earnings seen between $3.49 and $3.56 per share. This guidance was actually quite upbeat if you ask me given the worsening economic environment and period of dollar strength.

In November, it appeared that the company was indeed off to a good start of the year with first quarter sales up 6% to $13.6 billion. Adjusted earnings rose four pennies to $0.86 per share, all in line with the topline sales developments. While ARR rose 12% to $23.2 billion and remaining performance obligations were up 5% to $30.9 billion, the real growth in these metrics no longer exceeds reported revenue growth. Despite a tough environment, the company hiked the midpoint of the sales guidance from 5% to 5.5% the non-GAAP earnings guidance hiked by two cents.

It is not necessarily the extent of the hike in the guidance, but more the direction of travel which comes as a bit of a surprise, and is the impressive part as the strong quarter furthermore made that net cash has risen to $11 billion again.

And Now?

Trading at $47, shares have held up quite well this year, but adjusted for net cash the valuation only comes in a $44 and change. Pegging realistic earnings around $3 per share, valuations remain dirt-cheap at 14-15 times, amidst a strong balance sheet and quite resilient performance during this period of slower growth, albeit that inflation in the products business helps to drive revenue growth to a certain extent. More so, the company appears to have seen some discipline with M&A as well, as the company has reportedly walked out of talks to acquire Nutanix.

For me Cisco remains an interesting play, one which you have to play by buying at very cheap multiples and sell if multiples expand. Right now, we are somewhere in between cheap to fair value (based on valuation ranges in the recent past) as I am puzzled behind the guidance hikes in a toughening environment, as I would be waiting on a potential setback before getting involved again. While the improved operating performance is welcomed and appreciated, Cisco seems too large and diversified to not be impacted here.