Equity Analysis for Cisco (CSCO)

By Margin of Safety Equity Research

Cisco reported Q1 FY2012 earnings, and is seeing the first positive results of restructuring and organizational changes on operational performance.

During the quarter, Cisco upgraded its IP telephony services for midsize businesses, adding video, instant messaging and presence features; and in November acquired privately-held BNI Video which offers video back-office and content delivery network (CDN) analytic capabilities. This acquisition will strengthen Cisco’s Videoscape TV platform.

1Q FY12 highlights

Cisco beat its revenue and EPS guidance during the quarter, as total revenue increased by 5% year-on-year to $11.3 billion. Product revenues increased by 3% year-on-year to $9.0 billion, while service revenues showed a much stronger 12% growth to $2.3 billion, driven by strong demand for software solutions in all geographical markets. Product revenue was driven by collaboration products (+12% to $1.1 billion) as companies focused on productivity, and service provider video (+13% to $0.9 billion) due to increased demand for video services and market share gains; other segments performed worse and offset these gains.

Cisco reports that all segments registered year-on-year order increases despite several segments experiencing no revenue growth or even declines. Product orders increased by 13% year-on-year, driven equally by all geographic markets. The book-to-bill ratio was 1, higher than a year ago. These improvements suggest solid momentum for Cisco amid global economic challenges.

Non-GAAP gross margin was 62.4%, down from 64.3% registered in Q1-FY11, due to changes in the price mix, especially due to several transactions in China. Cisco expects the deals in China to impact the gross margin in Q2-FY12. Going forward, the company expects to remain competitive in the Chinese market, suggesting continued pressure on margins. Cisco reports that gross margin is its primary focus and has implemented remuneration of sales employees based on total profit contribution of their regions.

Non-GAAP EPS was $0.43, increasing by 2.4% year-on-year. Non-GAAP EPS grew slower than revenues mainly due to lower gross margin.

Cisco reports that it is on track to achieve the planned $1 billion reduction of expenses by the end of FY12. During the quarter, the company reduced its headcount by nearly 8,400 employees (down to 63,500) as a result of the sale of its Juares Mexico manufacturing facility and restructuring actions.

Nevertheless the company says it continues to be cautious looking forward given the recent events in Europe over sovereign debt, public sector spending, India business environment and the impact of the flooding in Thailand.

During the quarter, Cisco repurchased $1.5 billion worth of shares, with a further $8.7 billion remaining authorized under the current repurchase program with no termination date.

For Q2-FY12 Cisco expects revenue growth to be in the range of 7% to 8% year-over-year with non-GAAP EPS of $0.42-$0.44.

At $19, we still think this stock has room to run and our intrinsic valuation models suggest $26-29 as the fair market value.

Disclosure: Long CSCO (Purchased at $15.16 and $14.24).