US markets have just come off a decade where growth stocks have trounced value stocks, a trend which continued unabated amid disruption caused by Covid-19 and recession in 2020. With markets at all-time highs, in terms of levels and valuation, making a shift to value stocks will be a safer play.
Tech blue-chip Cisco (CSCO), networking/security company, provides a good value opportunity. A component of the Dow Jones Index (DJIA), CSCO is amongst the top 10 dividend-yielding stocks in the index and is the only company with net cash in its balance sheet among the top 10 dividend-yielding companies in DJIA.
The company
A poster child of the dotcom bubble – once during this period it had the world’s highest market cap – CSCO is one of the few networking companies that survived the tech bust that followed the bubble. Its business primarily consists of designing and selling a broad range of technologies and services that power the internet.
It does this via its five main business segments. One, Infrastructure Platforms which consists of switching, routing, wireless and data center products. Two, Applications which primarily consists of software-related offerings that build on core networking and data center platforms. Three, Security which provides solutions to network, cloud and e-mail security issues. Four, Other Products which mainly consists of emerging technologies. Five, Services – offerings to customers related to networking and security. Infrastructure Platforms is the leading segment accounting for 55 per cent of revenues.
CSCO is one of the most-diversified technology companies, given its presence across the spectrum of networking and security. Its competitors are usually companies that operate in one or few of the business segments that CSCO has presence in. Its customers span the B2B landscape of private enterprises, telecom service providers and public sector. It is also geographically well-diversified.
Recent performance
In recent years. the company’s business has been facing headwinds from the customers’ transition to cloud and data center vs on-premise IT spending (important revenue stream for CSCO). While company has been making strategic changes over the years to manage this transition, given its size and diversification. it is work in progress. In the interim, its revenue growth has been impacted, with revenues stagnant over the last five years into FY2020 (July). Despite revenues staying flat in recent years, it has managed to increase normalised EPS at a CAGR of 8 per cent during the same 5 year period, by a combination of cost controls/better margins and buybacks.
While many tech companies capitalised on Covid-induced digitisation trend, CSCO could not fully benefit from this as its exposure to on-premise and legacy business offset the segments (like Security and cloud driven sub-segments) that saw better growth due to digitisation. After a weak July quarter which bore the brunt of Covid disruption, company has started seeing trends improving in its October quarter and management sounded an optimistic tone on recovery.
CSCO has outlined a vision to transition majority of its business portfolio to an ‘as a service’ consumption model to cater to the accelerating digitisation trends.To drive this transition it is rebalancing its R&D investments to offer customers releveant technology in simpler, more easily consumable ways. The company has also revamped its Webex video-conferencing application to compete with Zoom Video. If successfully implemented, its new strategy could provide a good base for the company to grow revenues better and command relative valuation premiums which markets assign to ‘as a service’ business models vs licensing/product models. This strategy was further bolstered when company recently recruited the CFO of Autodesk who had enabled a very successful transition of the software company from licensing to a ‘software as a service’ company.
Over the last 20 years since the dotcom bubble, CSCO has demonstrated the ability to consistently grow earnings across market cycles and manage multiple transitions in the tech landscape successfully. This lends confidence to higher probability of a successful transition from here as well.
Valuation
CSCO trades at a modest PE of around 14 times next 12 months consensus EPS (Bloomberg) vs DJIA trading at 24 times. Both its discounted valuation vs the index and its absolute valuation factor challenges currently reflected in its business. It has net cash at approximately 8 per cent of its market cap. It has been consistently generating positive free cash flows of around $14-15 billion over the last few years and this is expected to continue. Cisco has a history of payout ratio at around 50 per cent for the last five years.
Given its cash flows, net cash balance and stable profits, current dividend yield of 3.2 per cent is sustainable and should provide downside support to the stock. It also offers an an option to benefit from good capital appreciation as the company effects a turnaround of its business. Investors can accumulate the stock on dips.
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