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Using a Value Line Report: Out of Favor Cisco Systems - June 22, 2012
Shares of Cisco Systems (CSCO – Free Cisco Stock Report) have been on a general downward course since late 2007 and the 2007 to 2009 recession. In fact, the share fell almost 40% over the trailing five years through May, while the broader market was up over 13%. (These cumulative return figures can be found in the lower right hand corner of the Graph.) That’s not a particularly inspiring performance and clearly demonstrates the frustration that investors have with the company’s performance.
Several years ago now, Cisco CEO John Chambers stood firmly behind the company’s long-term revenue projections of 12% to 17% annual growth. Then, shocking the market, he sent a memo to his employees acknowledging that unacceptable operational execution had disappointed investors, confused employees, and caused the company to lose credibility with its customers. He also expressed his intent to take sweeping action to streamline operations.
Based on the 2007 decision to alter the company’s organizational structure and enter 30 new markets over a three-year time frame, the uncharacteristic misstep was, perhaps, inevitable. At the time of his memorandum, Chambers lowered, “temporarily,” the company’s revenue growth rates to the 9% to 12% range for 2011. Unfortunately, He was later forced to lower them even further.
Failing to meet self-imposed market expectations tends to dampen the market’s animal spirits. Although the shares rallied from a low of about $13 in mid-2011 to a high in 2012 of about $21, they have since retreated again to the $17 range. (The yearly high and low price for a stock is shown above the Graph.) Value Line analyst Kevin Downing sums up the general feeling about Cisco nicely in the Analyst Comment when he says, “The company’s guidance leaves much to be desired.”
Indeed, he is expecting revenue growth to be in the 2% to 5% range in the final fiscal quarter of Cisco’s year. Recent positive comments from customers, however, might prove that estimate conservative, but, after so much turmoil, being conservative is probably the best course of action. With this background, and using a safety first line of thought, does it make sense to own Cisco?
Clearly, the company has struggled over the last couple of years. Much of that difficulty appears to be related to the size and breadth of the company. Growing pains aren’t uncommon as once tiny companies expand and mature. At a $90 billion market cap, Cisco is no longer the nimble player it once was (market cap can be found in the Capital Structure box). In fact, like so many other tech giants, Cisco has started paying a dividend—a clear statement that it has “come of age”.
Interestingly, as of April, the company had nearly $50 billion in cash on its balance sheet—more than three times the amount of debt it has. (Cash assets can be found in the Current Position box, while debt can be found in the Capital Structure box.) Its $16.4 billion in debt accounts for just 26% of the capital structure. Having enough money to survive doesn’t appear to be a particular issue for Cisco. In fact, it has enough money to make a few mistakes along the way to getting things right (a good thing based on recent events).
Even during the missteps of the last few years, Cisco has remained solidly profitable. This is a testament to the company’s market position. While one can’t take such things for granted, Cisco’s products are at the heart of the Internet—and rumor has it that the Internet isn’t going away any time soon. These factors, among others, help explain why Value Line has awarded Cisco an A++ Financial Strength Rating, the highest possible; this proprietary score can be found in the Ratings box. That score, in conjunction with a decent score of 80 (out of 100) for Stock Price Stability, helps explain the Safety Rank of 1, found in the Ranks box.
It is hard to say whether or not Cisco will start to surprise to the upside any time soon. However, the tech powerhouse clearly has money on its side, and that can buy a lot of time. Downing believes that Cisco shares “may interest conservative value investors.” That is an appropriate group, since the shares are trading well below their historical valuation measures. For example, the company’s recent relative P/E was just 0.73 (found in the Top Label that runs across the top of each Value Line report). Historically, even in difficult times, that ratio was well above one.
Moreover, the dividend, though not particularly large, makes it easier to wait for a recovery. Note, too, that the payout was increased in the June quarter, a fact displayed in the Quarterly Dividend box. That’s usually a sign of management that believes in a company’s future. To that end, Downing is projecting revenue growth over the coming three-to-five year period of 5% per year, found in the Annual Rates box. If even that conservative figure is the best the company can achieve, it will translate to earnings growth of about 7.5% and a price range of between $30 and $35 per share (found in the Projections box). That’s an annualized total return range, including dividends, of between 17% and 21% per annum. Conservative value-oriented investors should be pleased with those expectations.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.