Cisco Systems, Inc. (CSCO) is a dominant supplier of switches, routers, firewalls, and complementary networking products. Its products are mission critical for network performance, stability, and security.

It released its Q4 and FY2019 results and provided Q1 2020 guidance following the August 14, 2019 market close.

The broad investment community was not pleased with results and guidance and on August 15th ~8.6% was lopped off from CSCO's previous day's closing share price.

Long-term investors would be wise to closely look CSCO's current valuation.

Summary

  • CSCO’s share price plummeted ~8.6%, the most in ~6 years, after reporting Q4 and FY2019 results and lackluster Q1 guidance.
  • The U.S.-China trade dispute and a slowing global economy are leading customers to delay updates of their computer networks.
  • Chinese state-owned enterprises are not permitting CSCO to bid for business.
  • China represents ~3% of CSCO’s business.
  • CSCO has generated $12B+/year in Free Cash Flow in recent years.
  • On the August 15th Q4 Earnings Call management indicated the plan is to balance share buybacks and dividends to be at least 50% of free cash flow.
  • CSCO is currently attractively valued and offers a ~3% dividend yield.

Introduction

On May 21st I wrote a Cisco Systems, Inc. (CSCO) article in which I expressed an opinion that shares were richly valued.

Fast forward ~3 months and CSCO has released Q4 and FY2019 results following the August 14th market close. Results and guidance have not meet investor expectations and CSCO’s share price has retraced ~8.6% to close at $46.25 on August 15th.

Does the pullback in CSCO’s share price present a buying opportunity? Let’s have a look.

Big Picture

We are certainly living in interesting times and trying to predict how CSCO will perform in the short-term is a crapshoot. From a long-term perspective, however, CSCO’s technology is fundamentally redefining IT architectures to help customers manage the complexities of a multi-cloud world and to transform for the future.

On the Q4 2019 analyst call, CSCO’s Chairman and CEO covered the following recent highlights across CSCO’s portfolio.

On the infrastructure platform front, CSCO has spent the last couple of years re-architecting its entire networking portfolio to deliver new capabilities through its automation platform.

At Cisco Live, for example, CSCO launched several new technology innovations across networking domains to more effectively secure and manage users and applications across the entire enterprise from campus networks and wide area networks, to data centers and the IoT Edge.

It has added several artificial intelligence (AI) and machine learning (ML) software capabilities to improve network management through its automation platform.

In Q4, CSCO delivered data center network insights providing critical analytics and proactive network management capabilities through automation to increase its customers’ ability to troubleshoot and remediate their environments.

It also continues to invest in silicon and optics to build the next generation Internet for customers. The recently announced intent to acquire Acacia (see Event Presentation) is a good example of how CSCO is enhancing its silicon and optics portfolio to enable web scale service provider and data center operator customers to meet the increasingly fast growing consumer demand for data.

Cybersecurity continues to be the top priority for CSCO’s customers. This has resulted in CSCO reporting another consecutive quarter of double-digit growth.

CSCO is an industry leader in networking and cybersecurity and is investing in, and extending, its subscription based security innovations across its networking domains. By extending its ability to detect threats, CSCO is the only company providing an integrated end-to-end security architecture across multi-cloud environments.

In FY2019, CSCO expanded its family of cloud security solutions to help secure identity, endpoints and the network. CSCO has also extended this protection from the network to branch offices to roaming users with flexible solutions designed to secure its customers’ SD-WAN environments. This has led to accelerating customer adoption as they move or expand to the cloud.

In Q4, CSCO announced the availability of a full Web proxy capability on its global SaaS platform umbrella to complement its on-premise appliances.

In the Applications product category, CSCO’s collaboration business continues to perform well. It is leading the market in integrating AI and ML into its enterprise collaboration portfolio so as to help customers work smarter and to increase productivity.

Through its AI driven innovations like people insights, facial recognition and Webex Assistant, CSCO is driving expanded collaboration experiences on any device integrated with customers’ business process workflows. Building on these cognitive innovations, CSCO announced its intent to acquire Voicea, a market leading provider of voice-based artificial intelligence solutions. With Voicea's technology CSCO will be able to enhance its entire Webex portfolio with a powerful transcription service combining AI and automated speech recognition to enable more actionable meetings, improved productivity, and enhanced experiences.

Q4 and FY2019 Financial Results

CSCO’s results released August 14th can be found here and its accompanying Earnings Presentation can be found here.

Source: CSCO – Q4 and FY2019 Earnings Presentation – August 14, 2019

On the Q4 Earnings call, management indicated that CSCO experienced continued challenges in service provider space. The Americas was generally the same from an order perspective from Q3, Europe was positive, and in Asia there was continued weakening in the China service provider business. In addition, CSCO had two massive build outs in India in FY2018 which were not replicated in FY2019.

Given the ongoing US/China trade discussions situation which is front and center in the media every day, it was not surprising to have some analysts question the impact on CSCO’s business.

Management indicated that less than 3% of its business is derived from China. While this is a very small percentage, the dramatic drop in business derived from China will inevitably impact CSCO’s results and the drop-off was more significant than management had expected; management has indicated that CSCO is not being allowed to even participate in any bids issued by state-owned enterprises.

Q1 2020 Guidance

CSCO only provides guidance for the upcoming quarter.

Q1 guidance (normalized to exclude the divested SPVSS business) is as follows:

  • Q1 FY 2020 Revenue 0% - 2% growth;
  •  Y/Y Non-GAAP gross margin rate: 64% - 65%;
  • Non-GAAP operating margin rate: 32% - 33%;
  • Non-GAAP tax provision rate: 20%;
  • Non-GAAP EPS: $0.80 - $0.82;
  • GAAP EPS: $0.64 - $0.69.

Revenue for the divested SPVSS business for Q1 2019 was $0.168B. (cont'd.)

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Disclosure: I am long CSCO.

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