Disconnect? Cisco Shares Slump on Strong Report

“Big story though, is Cisco, coming off their earnings. I mean, it feels like there’s a disconnect going on. Cisco shares are down 3.75%, on earnings that were much better than expected.” – Fox Business Network 5/13/2010

Internet technology giant Cisco Systems (CSCO) reported fiscal third quarter results after the close on Wednesday that were at record levels and stronger than analysts expected, yet the stock has sold off more than 3% on heavy volume this morning. Bolstered by rebounding corporate technology spending, Cisco reported income of $2.2 billion or 37 cents per share which compares favorably to the $1.35 billion or 23 cents per share a year ago. Furthermore, after adjusting for one-time charges (comparable to analyst’s estimates) the San Jose, CA firm earned 42 cents a share and topped the consensus view of Wall Street by 3 cents.

Perhaps the earnings whispers are to blame for the sell-off or positive earnings surprises from other tech bellwethers made this report just par for the course. Either way, this morning’s reaction is not based on fundamentals which are clearly on the upswing. Much like profits, revenue growth was superb coming in at a rate of 27% and easily topping expectations. Cisco’s normally reserved CEO John Chambers went as far as to say the last quarter, “was probably the strongest quarter in our history.” He also said that their business has returned to balanced growth across various business segments and geographies.

The quarter did include an extra 14th week, a rarity that may provide one possible explanation for the strong results. However, looking ahead the company forecast 25-28% revenue growth in the fourth quarter, analysts had expected 25.1%. We expect the company will continue to be aggressive in mergers and acquisitions as they are generating cash extremely rapidly ($3 billion from operations in the third quarter). As of the end of the period, they had $35 billion in cash on hand and an eye-popping nearly $50 billion in current assets. With just over $6 per share in cash, the company is trading for a P/E of under 13x when you exclude cash.

At Ockham, we have a Fairly Valued rating on Cisco coming into this report. However, after the stock fell Thursday on stronger fundamentals, we may be inclined to upgrade in an upcoming report. Cisco trades near the low end of both their historical price-to-cash earnings and price-to-sales ranges, which suggests the valuation is favorable. Growth has returned to Cisco and as their CEO will attest they are hitting on all cylinders. Management has aggressively bought back shares in recent years and still has $9.3 billion left on its share buyback authorization. Assuming they continue this, earnings per share will continue to benefit.

There is no doubt Cisco is a cash generating machine right now and operations appear only to be getting stronger as they provide the pipes for the Internet. Over the last year, Cisco has tracked almost in sync with the iShares for the technology sector (IYW). The question investors must ask themselves is, does this best in class company not command a premium? We believe today’s reaction to earnings is a disconnect that creates opportunity for the long term investor.

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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