Earlier this year, Cisco (CSCO - Free Cisco Stock Report) chief executive John Chambers sent a memo to his employees acknowledging that unacceptable operational execution has disappointed investors, confused employees, and caused the company to lose credibility with customers. In keeping with his aggressive, no-nonsense management style, Mr. Chambers has expressed his intent to take sweeping action to streamline operations.
This, however, comes after the company its 2007 decision to alter its organizational structure by placing executives and vice presidents into boards and councils. Instead of doing one or two aggressive moves a year, Cisco used the new structure to enter 30 new markets over a three-year time frame, including virtual healthcare, safety and security, smart communities, consumer camcorders, and stadium-sized TV screens.
Although the stated goal was to reach the company’s aggressive 12%-17% annual long-term top-line target growth rate, it ultimately resulted in reduced management accountability and efficiency, in our view. The company has since, temporarily, lowered its growth expectations to 9%-12% for fiscal 2011. As the Graph on the Value Line report clearly shows, the stock market has not reacted kindly to the recent performance. Not only is the stock down materially, but its relative performance, denoted by the dotted line at the bottom of the Graph, has been woeful. Cisco shares now trade at the same levels as during the depths of the 2007-2009 recession (noted by the shaded area on the Graph).
As the Analyst Commentary points out, though, the organizational structure isn’t the only problem the company faces. Indeed, the company’s switching unit, a materially important operation for Cisco, has seen sales decline, as customers have traded down to cheaper alternatives, both from Cisco and its competitors. Public sector sales are also in the doldrums, as customers’ fiscal constraints have limited demand.
To combat the ills it faces, the company is streamlining the management structure and jettisoning non-core businesses, many of which the tech giant should probably have never been in to begin with, so that it may focus on its routing, switching and services, collaboration, data center virtualization and cloud, video, and architectures for business transformation “priorities”. Clearly, though, as the Graph illustrates, the stock market has yet to be appeased by these moves. Hard proof of a turnaround in performance appears to be the missing factor. We don’t believe this proof is going to start appearing for at least another six months.
So, should investors avoid Cisco shares? Perhaps not. While there are clear problems at the company, management appears to be addressing them. Moreover, despite the recent issues, company has, historically, been well-run, lending support to the idea that this ship will be righted. Then there is the compelling valuation.
To be fair, when we last highlighted this company in December, our three-to-five year projections were much rosier. That said, with the price having now fallen from about $27 per share in early 2010 to a recent price of about $15, even slightly reduced expectations provide for material upside in the stock. Indeed, we now expect revenues and earnings to be $9.75 and $1.70 per share, respectively, over the three- to five-year pull. These projections, shown in bold face type, can be found in the far right column of the Statistical Array.
Assuming, as we do, that the company can meet these performance expectations, we calculate a share price range of between $25 and $30 per share out to 2014-2016. This range is shown visually by the dotted lines to the far right of the Graph and numerically in the Projections box. This translates to a share price gain of between 65% and 100% from recent prices.
Note, however, that the company recently initiated a dividend. (As the
Quarterly Dividend box shows, the first payment occurred earlier this year.) Including the dividend in the calculation of total return results in an annualized return of between 13% and 19% over the projected period. This is a respectable return figure for such a large, financially strong company.
Moreover, at the recent price, the shares are trading at valuation levels lower than at any point in the last 17 years. Indeed, the P/E ratio relative to that of the average stock covered by Value line, shown at the top of the page, is just 0.78. This figure, meanwhile, is far lower than any Relative P/E Ratio shown in the historical portion of the Statistical Array.
Note, too, that while the recent missteps are upsetting, Cisco has some $43 billion of cash on its balance sheet (which can be seen in the Current Position box). That figure, meanwhile, is up from 2009—a period in which the company suffered operational issues. Additionally, its cash balance is well over twice the company’s debt. Clearly, the company is financially strong (note the A++ Financial Strength Rating in the Ratings box at the bottom right of the report) and can afford the time to get back on the right track.
It may seem odd to read, but high-quality Cisco stock may actually be an interesting value play at this time.
At the time of this article's writing, the authors did not have positions in any of the companies mentioned.