21 de October de 2018

Finally, Cisco Gets What It Deserves

Tech heavyweight Cisco Systems (CSCO) has recently beat expectations with its Fiscal Year Q1/2018 earnings and rallied ever since. Investors have finally discovered Cisco’s deep value and cheered enthusiastically about Cisco guiding to return to revenue growth in Q2/2018.

Following such an upbeat market opinion on Cisco it is time to review Cisco’s financial results and whether the stock still offers an attractive buying opportunity for dividend investors.

Source: Cisco Systems – all courtesy remains

What is going on at Cisco?

Cisco has a history of beating market expectations by a fraction and continued that streak with its fiscal Q1 report. It reported EPS beat of $0.01 and -4% revenue contraction.

More importantly than these figures is that the company reported a 3% rise in net income and saw its recurring revenue base grew to 32%. Even more impressive was the 10% growth in deferred revenue hitting $18.6B driven by subscription-based and software offers. That strong performance really shows that Cisco’s subscription story is fully intact and gaining momentum on the top-line as well.

The big news for the markets was Cisco’s guidance. For the first time since Q1/2016 Cisco is guiding towards (marginal 1-3%) revenue growth for fiscal Q2. That is a big event for company as big as Cisco sporting a market cap of over $185B currently.

As a result of such promising guidance the market sent Cisco stock almost 10% higher over the following days as its PE expanded from sub-18 to almost 20 times earnings.

CSCO data by YCharts

Capping a streak of several quarters of revenue contraction Cisco’s business transformation from traditional product offerings to subscription-based offerings is finally starting to show itself on the top-line. Interestingly, it is a well-known fact that such a business transformation initially leads to declining revenue as a large part is accrued for future periods.

Still, the market has been largely oblivious to that fact and basically ignored Cisco’s strong growth in deferred revenues and is now quickly reversing its opinion on Cisco, thus sending the stock higher, quickly and ferociously.

Let us highlight the importance of deferred revenue figures for Cisco further in order to demonstrate the sheer magnitude and importance they already have for the company.

The whole idea of that business transformation is to drive offers that were consumed perpetually to subscription, or to put differently, move existing offers to subscriptions. Thereby Cisco will be able to build a stable, reliable and recurring revenue base for its future which should be less susceptible to seasonality and other external factors. Executing such a strategy means that in the early years a lot of revenue which would have already been recognized under the old model is shifted into future periods. Unfortunately, it is not possible to accurately decipher how much revenue would have been recorded in each fiscal quarter by the old model but the things we do know sufficiently underline the success of that business transformation:

  1. Over the last four full financial years Cisco has recognized $2.3B of deferred revenues of which $1 billion alone originates from FY2017. This represents around 1.5% of total revenue and Cisco is expecting this impact to accelerate to 2-3% points on total revenue as we move from FY2017 to FY2020.
  2. Recurring offers now command a 32% share in total revenue up over 3 points Y/Y
  3. Deferred revenue increased to $18.6B and up 10% Y/Y with deferred product revenue rising 16%.
  4. Software subscriptions soared 37% Y/Y.

All this clearly shows strong growth and it is only a matter of time until we will see these figures recognized on the income statement as well. That steady and strong growth in deferred revenues has not suddenly emerged out of the blue as in fact the positive indicators have been existing for some time. Take for instance Cisco’s Security segment. Revenue increased by 8% but deferred revenue soared by 42% as the company saw continued momentum.

Although Cisco’s stock has anything but fared badly in 2017 (its performance only marginally trailed the SPY prior to fiscal Q1 earnings release), the stock has not benefited from the very strong tech rally in 2017. As a result it was only trading at a fairly cheap 18 times earnings valuation prior to earnings.

Now that the cat is out of the bag the markets are finally giving Cisco what it deserves, namely a higher multiple as top-line revenue growth is returning driven by strong growth in subscription-based offerings. As a result Cisco is outperforming the broad market and catching up on the tech rally.

CSCO data by YCharts

It should also be noted that Cisco’s 1%-3% revenue growth guidance is not entirely driven by the subscription model taking traction but also by a renewed strength in orders similar to Q1 where total product orders grew 1% driven by a 12% growth in the commercial customer segment. Still, as CFO Kelly A. Kramer remarks, the impact of deferred revenue growth is certainly more substantial despite remaining a headwind to higher revenue growth:

We’re still, I’d say, growing the base of the offers faster and putting it on the balance sheet than it’s coming off. But, again, both the year-over-year increase of the balance, the $5.2 billion was up 37% and my income statement was up 37% as well. But I’m still putting more and more offers and as we get scale through the core networking, not just on switching but the whole DNA Center, I think that’ll continue to add. So it’s still going be a headwind. And as I said before, this 1.5 to 2 points will move to more like a 2 to 3 points in the upcoming years as we get more scale there

Source: Cisco Earnings Call FY2018/Q1

As a dividend investor, by the virtue of its nature, I am very focused on the company’s dividend and dividend safety.

How about Cisco’s dividend?

Driven by a strong post-earnings rally Cisco’s yield is now hovering just above 3% and still offering tremendous value. Also, Cisco is due to declare a dividend raise in February.

The company has grown its dividend by a staggering 333% since its first ever dividend in 2011. The year-over-year increases have excited investors:

  • 2012: +33%
  • Late 2012: +75%
  • 2013: +21%
  • 2014: +12%
  • 2015: +11%
  • 2016: +24%
  • 2017: +11.5%

Such impressive dividend growth amidst declining sales has certainly increased the payout ratio. Right now, both the company’s cash dividend payout ratio and EPS payout ratio remain +/- 7.5 pp above/below 50%. In terms of free cash flow, the ratio stands at 70%, which is certainly not low but still comfortable for a stock yielding above 3% and with 7 years of consecutive double-digit dividend growth rates.

On top of that, Cisco is one of the richest companies in terms of cash reserves. Cisco currently sits on $71.6 billion in liquidity, which is up around $1 billion sequentially and Y/Y. The majority of that cash pile is held overseas with only $2.5 billion in cash and cash equivalents being available in the United States. Thus, the cash pile increased by around 7% despite the fact that the company raised its dividend by 11.5% in February 2017 and by a whopping 24% in February 2016.

As such dividend investors should not really worry about the rising payout ratios, as the dividend is rock solid and likely to be raised again in February. Cisco remains a cash flow machine and is very dedicated to its dividend while also eager to maintain enough fire power to strike another acquisition if deemed valuable.

Cisco’s next dividend has not yet been declared, but the stock is expected to go ex-dividend in early January.

To keep track of dividend payment and ex-dividend dates, I use the Dividend Calendar and Dashboard Tool, which shows my expected dividend payments, in this case for October 2017. Here we can see that I was expecting a sizable payment on October 24 from Cisco with the stock predicted to go ex-dividend around October 3.

Investor takeaway

In a previous article I wrote that

…the market is not really liking Cisco due to revenue declines and tepid growth outlooks

while also stating that

… once the company’s business transformation is complete and the market starts to fully appreciate Cisco’s enormous growth in deferred revenues, latest by then, Cisco’s stock will start trading at higher multiples.

Now that the market is finally appreciating Cisco’s subscription business model in combination with strong orders and multiple future-oriented acquisitions the stock has been shooting higher ever since. This new business model will help Cisco benefit from higher stability and less fluctuation in its sales and investors will be rewarded with a solidly growing business with a very strong base of recurring revenue.

Despite a strong almost 10% post-earnings rally and the stock’s multiple expansion from 18 to 20 times earnings I remain very bullish on the stock as Cisco continues to offer a stable, growing and very solid dividend for long-term oriented dividend investors while at the same time transforming its business and building a very strong base for future growth. Cisco is finally getting what it deserves and patient investors can handsomely benefit from it while also collecting a very attractive dividend, a simple WIN-WIN package.

What’s your opinion on Cisco? Are you buying into the post-earnings rally or waiting for a dip first?

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Disclosure: I am/we are long CSCO.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not offering financial advice but only my personal opinion. Investors may take further aspects and their own due diligence into consideration before making a decision.

Article source: https://seekingalpha.com/article/4129124-finally-cisco-gets-deserves

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