CSCO - Dividend Achiever Review

This Cisco Dividend Achiever review looks at whether Cisco, a company that has increased its dividend annually since April 20, 2011, is currently an attractive investment.

Over the course of several years, there has been an evolution in the term Dividend Achiever. We now have multiple Dividend Achiever Indexes. In a nutshell, however, a Dividend Achiever is a company with a history of enhancing shareholder value through the return of capital to shareholders.

A Dividend Achiever is either listed on the NYSE or the NASDAQ. A company must meet various criteria to become a member of this group as per NASDAQ's Dividend Achievers Index Methodology. The NYSE has similar criteria.

Cisco Systems, Inc. (CSCO) is currently not a component of NASDAQ's US Broad Dividend Achievers Index. We, however, see from CSCO's dividend history:

  • that the first dividend distribution on record is April 20, 2021;
  • a consistent annual dividend increase for at least 10 consecutive years.

Even NASDAQ's website reflects this information!

Although CSCO is not currently an official Dividend Achiever, there is little reason to suspect it will not become one very shortly.

Cisco - Dividend Achiever Review - Business Overview

CSCO designs and sells a broad range of technologies that have been powering the Internet since 1984.

It is in the business of integrating intent-based technologies across networking, security, collaboration, applications and the cloud. These technologies are designed to help customers manage more users, devices and things connecting to their networks.

CSCO conducts business globally and manages the business by geography.

The business is organized into 3 geographic segments: Americas; Europe, Middle East, and Africa (EMEA); and Asia Pacific, Japan, and China (APJC).

CSCO's products and technologies are grouped into: Infrastructure Platforms; Applications; Security and Other Products.

It also provides a broad range of service offerings, including technical support services and advanced services. Its technologies are increasingly being delivered through software and services.

A comprehensive overview of the company and the risks that may adversely affect the company are found in Part 1 of the FY2020 10-K.

Acquisitions, Investments, and Alliances

CSCO has broadened and improved its products and services offering through a series of acquisitions, investments, and alliances over the years.

The company's 5-prong 'build, buy, partner, invest, and co-develop' approach is as follows:

  • Build - Working within Cisco, with the developer community, or with customers;
  • Buy - Acquiring or divesting, depending on goals;
  • Partner - Strategically partnering to further build out the business;
  • Invest - Making investments in areas where technology is in its infancy or where there is no dominant technology; and
  • Co-develop - Developing new solutions with multi-party teams that may include customers, channel partners, startups, independent software vendors, and academics.

Details on its multiple acquisitions are accessible through the Earnings and Acquisitions section of CSCO's website.

Cisco - Dividend Achiever Review - Financials

Q3 and YTD2021 Results

On May 19, 2021, CSCO released Q3 and YTD2021 results; more detail is found in CSCO's Q3 10-Q.

CSCO is focusing on the acceleration of innovation and simplifying the adoption of its offerings with network-wide automation, analytics and flexible as-a-service consumption models.

Q3 results reflect a return to a strong spending environment and an economic recovery.

CSCO reports a 10% growth in product orders which is the highest growth rate since Q1 2012.

From a product revenue perspective, 6% growth was led by strength across CSCO's portfolio, including campus switching, routing, wireless, security, collaboration and webscale, as well as from the Acacia acquisition which closed in Q3.

CSCO continues to aggressively shift its business to more recurring revenue streams. Expectations are for further growth as product offerings are expanded. In Q3, CSCO achieved $3.8B in software revenue with 81% of software revenue sold as a subscription; this is an increase from 76% in Q2.

Q3 also saw another quarter of double-digit growth in deferred revenue and remaining performance obligations. The company has made significant progress over the past 6 years and now has one of the largest software businesses in the industry with an annual run rate of over $14B.

Importance of Deferred Revenue

With CSCO aggressively shifting its business to a recurring subscription basis there is a strong probability that deferred revenue will grow.

Deferred revenue is money CSCO receives before it is earned. An attractive feature of deferred revenue is that this money assists in the financing of operations; it can relieve the burden on other assets or reduce the need for financing.

This money can not be reported in CSCO's income statement because it has yet to 'earn it'. It is not a ‘real revenue’ so it does not get reported on CSCO's Income Statement. Instead, it is reported on the Balance Sheet as a liability. As CSCO delivers its products and services, revenue is added to the Income Statement. The entry is to debit or reduce the liability account, and credit or increase the revenue account. This is when deferred revenue turns into ‘real revenue’ and impacts CSCO's net income or loss.

Any amount CSCO expects to report as revenue within the next 12 months is a current liability. Any deferred revenue pertaining to products or services to be provided beyond 12 months falls under long-term deferred revenue.

This is why deferred revenue appears as a short-term liability and just before 'Other long-term liabilities' on page 3 of 91 of the Q3 2021 10-Q. As of May 1, 2021, CSCO has ~$21B of total deferred revenue (its clients' money) sitting on its Balance Sheet!

FY2021 Guidance

CSCO expects to achieve the following Q4 2021 results:

The Q4 2021 GAAP EPS estimate is $0.64 - $0.69.

Operating Cash Flow (OCF) Free Cash Flow (FCF)

Looking at the Condensed Consolidated Statement of Cash Flows in the historical 10-Ks we have FY2011 - FY2020 OCF of (in $B):

10.08, 11.49, 12.89, 12.33, 12.55, 13.57, 13.88, 13.67, 15.83, and 15.43.

Back out CAPEX (in $B) of: -1,174, -1,126, -1,160, -1,275, -1,227, -1,146, -964, -834, -909, and -770.

and we end up with FY2011 - FY2020 FCF of (in $B):

8.91, 10.37, 11.73, 11.06, 11.33, 12.42, 12.91, 12.83, 14.92, and 14.66.

In the first 3 quarters of FY2021, CSCO's OCF is $10.95B. Back out $0.53B in the acquisition of property and equipment and add back $0.014B in proceeds from sales of property and equipment and YTD FCF is ~$10.4B.

From the ~$10.4B in YTD FCF, the large outflow of funds has been ~$4.6B in distributed dividends, the repurchased ~$2.1B of common stock.

Cisco - Dividend Achiever Review - Credit Ratings

Moody's currently rates CSCO's senior unsecured domestic currency debt A1. This is the top tier of the upper-medium grade category.

This rating defines CSCO as having a STRONG capacity to meet its financial commitments. However, it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

The AA- rating assigned by S&P Global is one notch higher than that assigned by Moody's and is the bottom tier of the high-grade category.

This rating defines CSCO as having a VERY STRONG capacity to meet its financial commitments. It differs from the highest-rated obligors only to a small degree.

Both ratings are investment grade and are acceptable for my purposes.

Cisco - Dividend Achiever Review - Dividends and Share Repurchases

Dividend and Dividend Yield

We see from CSCO's dividend history that it recently distributed its first quarterly $0.37/share dividend.

In Q3, CSCO cash dividends of ~$1.6B.

Based on the current ~$53 share price, investors receive a ~2.8% dividend yield.

A company's dividend history may be of interest to investors. More importantly, however, is the company's ability to continue to increase its dividend. We see from CSCO's ability to consistently generate strong Free Cash Flow that future dividend increases are likely to be forthcoming.

Share Repurchases

In September 2001, CSCO's authorized a stock repurchase program. This program has no termination date.

In Q3, CSCO repurchased ~10 million shares of common stock under its stock repurchase program at an average price of $48.71/share for an aggregate purchase price of $0.51B. The remaining authorized amount for stock repurchases under the program is $8.7B.

CSCO's average outstanding shares in FY2011 - FY2020 are 5,563, 5,404, 5,380, 5,281, 5,146, 5,088, 5,049, 4,881, 4,453, and 4,254 (millions of shares). For Q3 which ends May 1, 2021 this has been reduced further to 4,215.

We see from the Condensed Consolidated Statement of Cash Flows that in the first 3 quarters of FY2021, CSCO has repurchased $2.096B of common stock under its repurchase program. It has also repurchased $0.419B of shares for tax withholdings on vesting of restricted stock units.

Cisco - Dividend Achiever Review - Valuation

Valuation - Adjusted Earnings

My last previous CSCO post on August 15, 2019 compares CSCO’s valuation relative to its historical valuation based on non-GAAP EPS as at the date of prior CSCO posts.

CSCO's YTD adjusted diluted EPS at the end of Q3 is $2.38 and guidance for Q4 is $0.81 - $0.83; adjusted diluted EPS guidance from 27 brokers is a mean and low/high range of $3.20 and $3.19 - $3.23.

If CSCO achieves $0.83 then FY2021 adjusted diluted EPS is $3.21. Shares are currently trading at ~$53 thus giving us a forward adjusted diluted PE of ~16.5. This level is comparable to the non-GAAP valuation in my previous articles.

FY2022 adjusted diluted EPS guidance from 27 brokers is a mean and low/high range of $3.40 and $3.29 - $3.59. This is a fairly wide range so erring on the side of caution I use the mean of $3.40 and the current ~$53 share price to arrive at a forward adjusted diluted PE of ~15.6. This level is also comparable to the non-GAAP valuation in my previous articles.

At the same time, I am cognizant of the fact that much can happen in a year. I am not, therefore, relying heavily on FY2022 broker estimates in trying to determine what is a reasonable level at which to acquire additional CSCO shares.

Valuation - GAAP

From a GAAP perspective, CSCO's YTD diluted EPS is $1.79. CSCO's Q4 guidance is 0.64 - $0.69. Using $0.67 for Q4, we can expect CSCO to generate FY2021 diluted EPS of $2.46. With shares trading at $53, the forward diluted PE is ~21.54.

For comparison purpose, CSCO GAAP PE in FY2011 - FY2020 is 15.59, 12.68, 12.19, 18.92, 14.44, 14.46, 19.95, 139.77, 19.03, and 18.12.

The well above typical PE in FY2018 is because CSCO reported $0.02 of diluted EPS. In FY2018, CSCO recorded a provisional tax expense of $10.4B related to the enactment of the Tax Cuts and Job Act. This amount is comprised of:

  • $8.1B of U.S. transition tax;
  • $1.2B of foreign withholding tax; and
  • $1.1B re-measurement of net deferred tax assets and liabilities.

If we compare CSCO's current diluted PE to FY2011 - FY2020 levels other than FY2018, CSCO's current PE is just at the high end of what I would consider fair. A PE of 19 and FY2021 diluted EPS of $2.46, for example, would give us a fair price of ~$46.74.

We have to remember that this is not an exact science. If CSCO's Q4 earnings come in at $0.69, the high end of guidance, the FY2021 GAAP earnings are $2.48. In addition, if we use a diluted PE of 20 instead of 19 we now arrive at a fair value of ~$50. Use a PE of 18 and we get a fair value of ~$44.64.

Since CSCO is not a high growth company (FY2011 - FY2020 revenue is 43, 46, 49, 47, 49, 49, 48, 49, 52, and 49 - in $B) I err on the side of caution and place more reliance on a PE of ~18 than a PE of ~20.

Cisco - Dividend Achiever Review - Final Thoughts

I hold CSCO shares in a 'Core' account and a 'Side' account within the FFJ Portfolio. The average cost of the shares held in the 'Core' account is $20.67 and the average cost of the shares held in the 'Side' account is $46.70.

I mention this because CSCO is a classic example of what can go terribly wrong when we disregard Valuation. During the .com heyday, CSCO's valuation was ridiculous. Shares were trading at a 'nosebleed' valuation.

Fast forward to the present. Two decades after the .com bubble burst, CSCO's current share price is well below the March 2000 high of ~$80/share!

In my opinion, many investors of today have yet to experience what happens when there is a total disregard of valuation. This is one reason why I think we see a rich valuation in so many equities.

I continue to think we will witness a softening in the equity markets. I am, therefore, in no rush to add to existing positions and am trying to apply the Discipline and Patience attributes of Charlie Munger’s 13 Personal Attributes To Improve Investment Success.

Stay safe. Stay focused.

I wish you much success on your journey to financial freedom!

Note: Please send any feedback, corrections, or questions to [email protected].

Disclosure: I am long CSCO.

Disclaimer: I do not know your individual circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own research and due diligence. Consult your financial advisor about your specific situation.