Cisco Systems, Inc. (NASDAQ: CSCO) has recently unveiled its fourth-quarter fiscal performance for 2023, resonating with a remarkable double beat that has ignited a blaze of optimism for its future. As the earnings stage was set, investor worries loomed over potential clouds of uncertainty due to a slowdown in enterprise cloud spending. However, armed with a diverse clientele and a surge of AI-driven confidence, Cisco has masterfully showcased its resilience, triggering an exuberant surge in its share price. Once more, Cisco asserts its prowess and cements its value in the ever-evolving technology landscape.
Cisco reported revenue of $15.2Bn, showcasing 16% growth to exceed the $15.05Bn consensus. As a result, earnings per share (EPS) enjoyed a mammoth 37% expansion, coming in at $1.14, above the $1.06 forecast. Adding to the optimism was CEO Chuck Robbins, who commented that the company added three percentage points of market share across its largest networking markets and expects further gains as we advance. Their diverse customer base of over 1M customers and partners has given them the reputation of a “shelter” in the storms of uncertainty, but their future growth remains unclear.
Technical
On the 1D chart, the share price has traded upward, resulting in an ascending channel, with dynamic support being found before the gap-up on the earnings release. From the late-October bottom, the share price has retraced past the 61.8% Fibonacci golden ratio at $54.55, but the upward momentum could fade in the upcoming sessions.
The 14-day RSI points to overbought conditions, which could cause a correction to $54.55, placing the dynamic support close to $53.92 under pressure. If a breakdown occurs at the channel, lower support exists at $52.25 and $51.58, the Fibonacci midpoint. Neckline support is established at $50.07 in the case of a sustained downside.
However, the 50-SMA is trading above the 200-SMA, suggesting medium-term bullish momentum that could cause a push through the dynamic channel resistance toward $56.93. From there, the estimated fair value of $59.19 is within reach, presenting a 6.73% potential upside.
Fundamental
The graph below shows Cisco’s performance relative to the S&P 500 and Nasdaq 100 index year-to-date. It is no secret that the technology sector has experienced a boom in recent months, backed by optimism around artificial intelligence adoption across the industry. However, Cisco has failed to keep up, only returning 16.37% to the Nasdaq’s 36.54%. This is partly due to the fears surrounding a slowdown in corporate spending, with discretionary items like cloud infrastructure landing relatively high on the list of cost cuts companies were forced to make. So, investors could ask themselves whether Cisco holds the potential for significant AI expansion without the inflated valuations that most other companies offer. Based on the CEO’s recent comments on AI in the earnings call, this could be possible.
Source: FairMarkets Australia – Koyfin, Tiaan van Aswegen
The company’s revenues realized healthy growth in the last quarter, up 16%. This was driven by a strong performance in product sales, which rose 20% to $11.65Bn, while Services advanced 4% to $3.55Bn. Software revenue was up 17%, with 20% growth in subscription revenue, which bodes well for future predictability of revenue as a more significant portion of their top line comes from recurring revenue. In addition, the company added 11% to their remaining performance obligations, now standing at $34.9Bn. From a segmental perspective, Core Networking revenue advanced an impressive 33%, now accounting for more than half of the top line. However, other segments did not perform as well, with Internet for the Future up only 3%, while the Security segment remained flat, and Collaboration declined 12%.
Considering the recent concern over future demand, the 33% growth in product sales paints a positive picture from face value. However, it is worth noting that the company’s backlog surged during the Covid-19 pandemic, as supply chain constraints prevented the company from fulfilling all obligations. Therefore, the recent expansion in revenue growth could potentially be unsustainable as the company continues to work down its backlog, as management expects the latest excess to be worked down in the first quarter of its next fiscal year. After that, revenue growth should normalize again. The concern is that their revenue growth is quite prone to swings in economic conditions, as shown in the volatility of revenue growth in the graph below. The recent shift toward subscription revenue does, however, provide a sense of stability that could prevent these sizeable swings in the future. However, management’s guidance for the full-year 2024 was for $57Bn – $58.2Bn, reflecting only a 0% – 2% expansion from 2023. This guidance missed the consensus for $58.37Bn and confirmed the caution over a revenue slowdown as we head into a new fiscal year.
Source: FairMarkets Australia – Koyfin, Tiaan van Aswegen
On top of their subscription revenue, there are also additional avenues for growth that management could explore. With the recent blowup in artificial intelligence and its adoption into business practices, there has been increased demand for chips that can handle large amounts of data throughput. Cisco’s Silicon One family of chips has been designed for this exact purpose and could unlock an additional revenue stream to benefit from this demand. While there is not a significant effect on the current top and bottom lines, the company has revealed that it has already recorded $500M of AI-related product orders, with management believing that Cisco could be the leading supplier of AI workload networking gear in the future.
Due to the surge in revenue as the company worked through its backlog, there has been a stellar margin improvement as of late. Gross margins are up to an impressive 64.21%, with the EBIT margin and Net Income margin trading at 29.4% and 26.03%, respectively. These metrics show a significant improvement from the late-2022 profitability slump due to their supply chain headwinds and are now well on their way to reaching the highs of the early months of 2021.
Source: FairMarkets Australia – Koyfin, Tiaan van Aswegen
So, coming back to the earlier question of whether Cisco provides AI opportunities at a lower price. As mentioned earlier, management is confident in the company’s ability to unlock incremental revenue from the adoption of AI and believes Cisco is well-positioned to benefit from the increased demand. From a valuation perspective, it becomes evident that they are relatively undervalued by some way compared to other IT players that are also taking part in the AI hype. With a P/E of 18.1X and a P/B of only 5.1X, the company does provide a relatively low price for its offering. However, the benefits of AI are not yet reflected in their current financial reports, and investors will essentially be taking a bet that they will be successful in their adoption. Other companies like Nvidia and Microsoft trade at much higher multiples, but for a good reason, as they have already given investors clarity on how they will monetize AI and the extent of the benefit that their overall performance can be expected to achieve. So, it is up to the investor to decide whether they are convinced of Cisco’s success in integrating AI into another layer of revenue expansion and base their investment decision on a risk-return trade-off between lower valuations at higher uncertainty.
Source: FairMarkets Australia – Koyfin, Tiaan van Aswegen
Summary
Cisco took centre stage last week to deliver a double beat in their latest quarterly report. While guidance for the upcoming quarter exceeded expectations, investors are weary of a slowdown in revenue growth, reflected in management’s conservative outlook for the 2024 fiscal year. However, suppose management can continue to grow its subscription revenue for software while unlocking additional growth in the world of AI. In that case, there is a 6.73% potential upside from current levels to the estimated fair value of $59.19.
Sources: Koyfin, Tradingview, Yahoo Finance, Reuters, Cisco Systems, Inc.
