Thursday, February 13, 2014

Cisco's Fiscal Second Quarter 2014: Nothing New From the First

After looking back at our lengthy post on 1Q FY14, Cisco's recent announcement of 2Q FY14 results didn't seem surprising. The bottom line is that analysts rate a fair value of $20 for the stock based on about $2.00 in EPS and a P/E about 70% lower than that of a competitor like Juniper Networks.  Again, I get concerned when stocks are priced for perfection, but when they're priced like a "going out of business" sale that's the time to look closely at the risk/reward ratio.

Quarter two's revenues of $11.2 billion were 8% below the prior year, which is at the low end of the projected range of an 8-11% decline.  Non-GAAP net of $2.5 billion was down 7%,  and adjusted EPS of $0.47 compared to $0.51, including a substantial charge for defective component chips from a trusted vendor.

The gross margin pressure which everyone is looking for continues apace. The product gross margin of 59% is, as one analyst pointed out, the lowest rate in ten years. The consolidated GAAP gross margin rate was 53%, but 61% on a non-GAAP basis. Again, not nice to look at, but this is a common phenomena among all the tech giants, save for Apple and Google, whose models are quite different.

For example, Cisco has decided to get out of the low margin set top business, while today's papers have stories about Apple reportedly getting ready to launch a set top business.  Inconsistent?  Different business models.  For Apple, it has yet to launch a product for which its customers aren't willing to pay a premium price, and so given their proprietary, closed iOS and their approach to content, this could be a nice niche for them.  Or, it could be their first stumble: I surely don't know.  For Cisco, with its goal to be the leading provider of infrastructure and management across the Internet and its plumbing, it makes perfect sense to get out of the box business.

Free cash flow of $2.3 billion was 6% ahead of the prior-year period. $4.9 billion was returned to shareholders, comprised of $4 billion in share buybacks and $900 million in dividends.  This was a record. The quarterly dividend was raised from $0.17 per share to $0.19.  Shareholders are getting paid for waiting.

Meanwhile their list of acquisitions and continuing integration of prior acquisitions continues.  If they are overpaying, it isn't hurting the balance sheet.  Emerging markets are a weakness.  They are in total chaos for all vendors in many product lines.  Is this a big deal now?

Cisco still has one of the strongest sales forces in the industry.  If they didn't, how did they get to this point?  To grow and retain this force, they have to execute a strong new product portfolio refresh, and this is where they should be putting money and management time. Share buybacks above $20?  Back off the accelerator unless the stock craters, which doesn't look like it's in the cards.

Cisco, IBM, HP and Microsoft.  There's value in there somewhere.

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