Every quarter for the past couple of years or so, investors have waited with bated breath for networking equipment giant Cisco Systems to report its results and give its outlook, hoping for a sign of some upturn in the industry -- and in virtually every quarter they have been disappointed.
In the latest quarter, the company's sales and profit climbed by a larger-than-expected amount, and there were even a few crumbs of optimism from CEO John Chambers. But is that going to be enough for a market that has already pushed the company's stock price up by almost 80 per cent in just the past eight months?
Cisco's quarter was definitely a good news/bad news story -- with a few glimmers of hope to keep the bulls happy, but enough question marks to keep the skeptics wondering. On the good news front, the company said that revenue climbed by more than 5 per cent in the quarter to $5.1-billion (U.S.) and profit per share rose by 87 per cent to 15 cents a share from 8 cents.
So why didn't the stock skyrocket? Cisco shares were only up about 5 per cent following the news.
There are a couple of possible reasons for the lacklustre response: for one thing, the stock has already almost doubled in less than a year as investors have been pricing in a tech-sector recovery. Several analysts have also pointed out areas where Cisco's results were somewhat less exciting than they appeared.
For example, a large proportion of the revenue increase in the latest quarter came from two factors. The first was the acquisition of consumer networking company Linksys this year, and the second was a large amount of year-end buying by the government. In fact, without that rush of government purchases, Cisco's U.S. sales would have been roughly flat over the preceding quarter.
The company's gross profit margins also fell in the quarter to 68.7 per cent from 70 per cent. This is something most industry watchers predicted following the Linksys acquisition, since that company's consumer products have much lower profit margins that Cisco's main corporate equipment business. However, the bulls point out that strict cost control managed to keep net profit margins from dropping as far as they might have.
Also on the glass-is-half-empty side of the picture, Cisco's cash flow from operations -- that is, the money it made from its actual business, rather than its stock portfolio or other assets -- fell in the quarter to $973-million from $1.1-billion. The closely watched "book to bill" ratio, which measures the number of new orders, was also somewhat less than rosy. It came in below 1, which means that Cisco's business shrank rather than growing.
Mr. Chambers' comments didn't exactly flash a big "All Clear" signal either. Among other things, the Cisco CEO -- who has no doubt become fairly gun-shy over the past couple of years when it comes to growth forecasts -- said Cisco is "slowly seeing increasing, very cautious business optimism." Later, he said that "we are seeing a number of potentially positive signs of economic recovery."
There are a few other caveats that any Cisco-watcher should be aware of, some of which crop up every quarter — including the fact that Cisco spends billions of dollars buying back its own stock, which helps boost its earnings per share by reducing the number of shares outstanding. During the first quarter alone, for example, Cisco spent $2-billion buying back more than 100 million of its shares.
The good news -- the revenue increase, maintaining its net profit margins despite lower prices, good cash generation, etc. -- was enough to cause some cheering on Wall Street, including upgrades from Piper Jaffray and RBC Dominion Securities, both of which boosted their ratings to "outperform." Oppenheimer also upgraded it to a "buy," while Deutsche Bank subtitled its research report "The Recovery Has Begun."
Some analysts, however, pointed out that despite the better news, Cisco is still priced for perfection. Sanford Bernstein analyst Paul Sagawa, for example -- one of the first to correctly forecast the telecom equipment downturn -- boosted his profit targets but kept his "underperform" rating, based on the stock's "strained" valuation. In fact, Mr. Sagawa's stock target is just $12, or about 50 per cent lower than it is now.
The Sanford Bernstein analyst said in his report that while the stock might trade into the mid-20s based on the market's optimism about technology, "In the long run, we believe that Cisco's current value will be very hard for the company to justify." He added the current price "implies very difficult to achieve performance" and assumes a rate of growth that is "nearly unprecedented, even for companies of Cisco's caliber."
Fulcrum Global, meanwhile, upgraded Cisco from a "sell" based on the company's quarter, saying its previous thesis about the networking equipment maker was wrong. The firm said it assumed that lower prices would mean lower net margins, but that Cisco had shown it could produce enough revenue growth to make up for those lower prices. However, the brokerage firm could only bring itself to upgrade the stock to a "neutral."
Even some of those who are optimistic about the company's prospects aren't so sanguine about the stock price, it seems.
© The Globe and Mail
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