In its first quarter of fiscal 2016, ended October 24, Cisco (CSCO) reported healthy financial performance. The firm grew total revenue 4% to $12.7 billion from the year-ago period, and non-GAAP earnings per share advanced more than 9% to $0.59. Top-line growth was led by emerging markets revenue growth of 11%, driven primarily by Mexico and India. The strong US dollar has impacted performance in countries such as Brazil and Russia to a degree, and we don’t expect this headwind to subside in the near term.
Cisco continues to transform its revenue model to a greater recurring mix thanks to a 10% increase in deferred revenue in the fiscal first quarter. Software and subscriptions led the deferred revenue growth, jumping 36% on a year-over-year basis, which reflects the shift of the company to a more software and cloud based business. Also in the quarter the firm effectively managed operating costs, as non-GAAP operating expenses fell 1% from the year-ago period, mostly due to nearly a 3% decrease in sales and marketing. This helped drive operating income up 8% to $3.9 billion in the period.
Critics may argue that Cisco has sacrificed growth in a rapidly evolving industry for margin improvements, most likely pointing to the reduction in sales and marketing costs, and though we cannot necessarily refute the root of the argument, we do have a hard time painting this in a negative light. The firm’s solid bottom-line performance helped it grow cash from operations 11% in the quarter, which was outdone by free cash flow growing more than 13% to a total of $2.5 billion. Cisco’s cash-rich business model is hard not to like from a fundamental perspective.
However, investors are always laser-focused on quarterly guidance updates, sometimes too focused, in our opinion. After the first quarter of fiscal 2016, management delivered weaker guidance than many were hoping to receive due to weaker than anticipated order growth in the first fiscal quarter. The company cited macroeconomic uncertainty and currency issues as the main drivers behind the weak order growth–it sells ~90% of its products exclusively in US dollars. Revenue growth is expected to be flat to 2%, and non-GAAP earnings per share are anticipated to be in a range of $0.53-$0.55.
Though many investors were not pleased with these short-term expectations–not that we are particularly pleased either–we use these quarterly results merely as a piece to a much larger puzzle. Further, Cisco reached the high end of its revenue growth expectations and beat its non-GAAP earnings per share guidance in the fiscal first quarter. The company continues to target 3%-6% organic sales growth.
Cisco has continued its strategy of completing small tuck-in acquisitions in the ever-changing software and security market, where complimentary technologies can grow far more rapidly when exposed to the firm’s scale and research and development capabilities. We continue to believe this is a quality use of the firm’s significant cash, cash equivalent, and investments position of $59.1 billion, which far surpasses its total debt of $24.6 billion. The company also repaid more than $850 million of its debt in the fiscal first quarter.
While it was using its cash to strengthen its balance sheet and competitive position in its industry, Cisco continues to pay a competitive and reliable dividend. At recent price levels, Cisco’s annualized dividend yields ~3.2%, and its Dividend Cushion ratio is well above 3, making it one of the most attractive dividends on the market, in our opinion. Given this ample amount of dividend coverage, we can do nothing but applaud the firm’s decision to repay debt and make strategic acquisitions.
Cisco has registered a 9 on the Valuentum Buying Index multiple times in the past four years, and with shares currently trading at ~$27, the company is materially undervalued, based on our fair value range of $30-$44. The firm continues to be one of our best ideas on the market today.