Cisco's Earnings Were Solid Despite Macro Challenges
Cisco ( CSCO ) announced a healthy set of Q2 FY 2013 results February 13 as revenues grew 5% and operating income 2% over the same period last year. A one-time tax benefit however helped Cisco grow its net income by a huge 44% y-o-y. Despite a challenging macroeconomic environment, the networking giant continued to perform better than rivals such as Juniper Networks ( JNPR ) - a good sign that its turnaround efforts in shoring up key routing and switching businesses are paying off. Network spending in Europe, which accounts for close to 20% of Cisco's revenues, continued to decline due to the ongoing macroeconomic concerns. This was however largely offset by sales in the U.S. which sustained its recent strong showing and the emerging markets in Asia-Pacific which grew at a healthy 8% y-o-y.
The slow return to strength of the enterprise sector in the U.S. is a big positive for Cisco since it derives almost 60% of its revenues from the region. However, the company's stock fell almost 2% in after-market trading as expectations were already very high following its 25% rally in the past three months. On the other hand, we continue to see far more value in the stock coming from Cisco's renewed focus on its core networking areas and underlying profitability following its recent restructuring initiative.
We believe the company is going in the right direction since the moves not only allow it to innovate faster but also streamline its businesses around its core networking products that contribute almost 40% to our estimated $26.50 fair value for Cisco , with cash contributing another 20%. At the same time, we expect Cisco to benefit from the long-term growth trends of data demand and cloud computing which continue to remain sharp. Our price estimate is about 25% ahead of the current market price.
Strong data demand despite macro concerns
One of the big concerns that surrounds the networking sector currently is the macroeconomic environment in which the customers - enterprises and service providers - have to operate. Due to macroeconomic uncertainty caused by the burgeoning debt levels of governments worldwide, corporates over the past year or so have become extremely cautious with their network spending. This has impacted the top-line growth of the networking sector as a whole.
In this challenging business environment, Cisco continues to be conservative in its guidance for the future but indicated that there are signs of a "soft global recovery" with parts of Europe still under distress. Juniper's earnings commentary last month was also along similar lines, implying that the rest of the year could see a steady ramp-up in network spending.
As optimism slowly returns, we expect enterprises to loosen their purse strings more and invest heavily in their network infrastructure. This is because the macro concerns have had little impact on data demand which has continued to remain strong driven by the key trends of mobile Internet and cloud computing. Specifically, mobile data traffic has grown exponentially with the proliferation of mobile devices such as smartphones, e-readers and tablets. According to a recent Cisco VNI report, mobile data traffic grew 70% in 2011 and is expected to grow at a CAGR of about 65% over the next five years. ((Global Mobile Data Traffic Forecast Update, 2012-2017, Cisco, February 6th, 2013)) The strong data demand means that enterprises and service providers will not be able to hold off spending on network upgrades for much longer.
Cisco prepares for upcoming trends
While the fundamentals of the industry seem strong, Cisco also seems to be addressing the shifting trends in the networking sector. With its recent Intucell acquisition, we believe Cisco is meeting the SDN threat head-on as well as increasing its exposure to the service provider market. (see Cisco Buys Intucell With An Eye On The Service Provider Market And SDN Threat) Its recent move to acquire NDS Corp was made to embrace software and drive device-agnostic video consumption in order to increase the demand for its routers and switches among service providers. (see Cisco's NDS Acquisition Taps Video Demand To Boost Network Equipment Business) As for the enterprise, the company debuted its virtual cloud-routing and WAN optimization platform under the Cisco Cloud Connected Solution brand to enable businesses that are increasingly looking to move their applications to the cloud at a low cost. (see Cisco's Worth $23 On Cloud Foray And Enterprise Strength)
Overall, we believe that Cisco is executing well on its turnaround plans and is well-positioned with its new-found focus to gain higher ground going forward. (see Cisco's Post-Earnings Crash Makes The Stock Look Incredibly Cheap) The company's dominant market position as well as aggressive price cuts have helped it gain market share from rivals Juniper and Alcatel-Lucent in an uncertain economic environment so far and could help it even further when the concerns subside. However, Alcatel Lucent's recent foray into core routers poses a downside risk for Cisco seeing as the former is #2 in edge router market share - a position of strength that it can effectively leverage to provide an end-to-end solution to its customers.