Cisco Systems, Inc. (NASDAQ:CSCO) stock touched a new 52-week high early on Friday, approaching a 17-year high following a big analyst upgrade. Cisco Systems stock has been steadily gaining since mid-November when the company issued strong earnings and guidance.
Cisco Systems stock upgraded to Buy
Bank of America Merrill Lynch analyst Tal Liani upgraded Cisco Systems stock from Neutral to Buy and boosted his price objective from $37 to $46 per share in a note to investors on Friday. He believes the tech firm is just beginning a positive transformation into software. In conjunction with that transition, he believes Cisco Systems stock is beginning to re-rate to levels that are closer to those of the company’s “industrial-like peers.”
He noted that making the transition to a focus on software isn’t exactly a new strategy, but he feels that this is the right time for Cisco to make such a move because of the tax reform bill and tailwinds for domestic capital expenditures. Bloomberg data showed last month that Cisco Systems was among the top five tech firms in terms of the size of its overseas cash balance, meaning that it could benefit greatly from being able to repatriate stacks of cash.
Liani also has become more optimistic about the company’s stability after years of uncertainty around software-defined networking and the public cloud. He added that Cisco management has proven so far that it’s able to mitigate these headwinds via investments and by “slowly steering the ship to software, recurring revenues and growth.”
Cisco could exceed its targets
The BAML analyst pegs Cisco’s fiscal 2020 earnings per share at $2.85 on the back of greater-than 30% exposure to software revenue by then. He notes that mixing multi-cloud solutions with software-as-a-service and hybrid on-premises solutions is complex, but he believes that this complexity will play right into the company’s strengths.
Further, the Internet of Things, 5G mobile technology and broadening digitization across industries is bringing about a “new era of edge computing,” he said, and it’s one Cisco can excel in, he believes. He also pointed out that Cisco Systems making acquisitions to grow its software revenue and expanding its cloud-based and SaaS offerings while also adding subscription elements to its legacy hardware products.
For example, Cisco acquired software maker BroadSoft in October for $1.9 billion; the transaction was expected to close in the first quarter of 2018. Cisco management said at the time that BroadSoft would expand the company’s on-premises offerings.
He sees the potential for all these efforts to boost Cisco’s software revenues beyond the 30% software revenue exposure target the company has set for fiscal 2020. He feels that all of these “stable and high-margin revenues” will help pave the way to greater-than $2.85 per share in earnings in fiscal 2020. This would represent a 6% compound annual growth rate for earnings through then and a 37% revenue contribution for software in what he describes as a “modest bull scenario.”
Catalysts for Cisco Systems stock
He also cited free cash flow, dividend growth and cash repatriation as positive catalysts for Cisco Systems stock. In Liani’s view, Cisco Systems stock is trading at a discount versus both the market and its peers at 12 times enterprise value/ free cash flow, while the S&P 500 is trading at 25 times.
He also pointed out that the gap between Cisco Systems stock and the market has been steadily widening over the past five years and sees it as “one of the cheapest stocks versus all large cap tech and networking peers.” He highlighted the EV/ FCF metric as being of particular importance for Cisco Systems stock because it captures the transition to subscription revenues and increase in the company’s cash balance.
Cisco Systems stock climbed by more than 1% in intraday trading on Friday, touching $39.88 per share before retreating slightly. Most of 2017 was difficult for the tech giant as investors eyed cuts in federal spending and waited to see evidence that progress was being made in the software transition.
