Cisco Looks Cheap at 13x Forward Non-GAAP Earnings But Fundamentals Are Deteriorating

Image: Cisco has ratcheted down expectations during the past couple quarters, and its shares have been choppy for the better part of a year now.

By Brian Nelson, CFA

On February 14, Cisco Systems, Inc. (CSCO) reported mixed second-quarter fiscal 2024 results that showed beats on both the top and bottom lines compared to previously lowered expectations, but overall lower revenue growth and weaker cash flow trends. The company is experiencing slow demand for networking equipment as it continues to work toward completion of its deal for cybersecurity firm Splunk. Though we didn’t like Cisco’s revised outlook for fiscal 2024, the firm is trading at just ~13x forward non-GAAP earnings per share. Cisco increased its dividend payout modestly and currently offers investors a forward estimated dividend yield of ~3.1%.

The headline results for Cisco’s second quarter of fiscal 2024 weren’t great. Revenue fell 6% in the quarter on a year-over-year basis, while net income dropped 5% and diluted earnings per share edged 3% lower, all on a GAAP basis. Net income declined 3% and earnings per share declined 1% on a non-GAAP basis in the period. Revenue weakness was prevalent across the board, with the Americas (-4%), EMEA (-7%) and APJC (-12%) regions all experiencing meaningful declines. Though sales in the company’s valuable ‘Services’ segment increased 4% on a year-over-year basis, its ‘Networking’ segment experienced a 12% decline in revenue (total product revenue dropped 9%), as the company continues to work aggressively to move more to a recurring revenue business model. Product orders also declined 12% on a year-over-year basis in the quarter due to uncertainty in the macro backdrop and customers working through recently-delivered shipments.

Looking ahead to fiscal 2024, Cisco issued revenue guidance in the range of $51.5-$52.5 billion, which was lower than the consensus forecast, while non-GAAP earnings per share is targeted in the range of $3.68-$3.74, also below what the Street was looking for prior to the report. Along with the weak guidance, Cisco announced a restructuring plan that will axe roughly 5% of its global workforce, as it better aligns its cost structure with lower expected demand. Cisco retains a net cash position at this time, but its all-cash deal for Splunk will challenge that. Cisco’s free cash flow has also been less than cash dividends paid during the first six months of its fiscal year, and operating cash flow was particularly weak in its fiscal second quarter due in part to the timing of federal tax payments ($0.8 billion versus $4.7 billion in the same period in 2023). 

We’re not liking what we’re seeing from Cisco Systems these days, and this is a change from our generally more upbeat view during the past several months. Revenue is under pressure, guidance continues to come in lower than expectations, its balance sheet will weaken as a result of its pending deal for Splunk, and free cash flow trends haven’t been as strong as they used to be. The company is adjusting its cost structure with layoffs as it continues to work to transform its business model to be more recurring, but the near term will likely continue to be challenging for the company. If free cash flow does not meaningfully improve in the next couple quarters, we’ll look to remove Cisco from the newsletter portfolios, despite its attractive ~13x forward non-GAAP earnings multiple.

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