Cisco's (NASDAQ: CSCO) earnings announcement shows a company that is slowing reinventing itself. In Cisco's recently reported first fiscal quarter, the company modestly beat analyst expectations on the top and bottom lines with revenue at $12.14 billion versus $12.11 billion expected and adjusted EPS at $0.61 versus $0.60 expected, according to Thomson Reuters.
Although the stock rallied on the announcement, critics counter by noting the company reported a 2% year-over-year revenue decline and gross margin compression of 2.6 percentage points as the core network hardware market continues to experience commoditization. Should buy shares of this cheap company or wait for more progress?
Teaching old tech new tricks
Cisco faces the same issues Microsoft and IBM does. In different ways, each of these tech companies were tethered to hardware sales. Microsoft required a hardware purchase (or an upgrade) to sell a version of its operating system, while IBM and Cisco provided the core processing, storage, and network hardware needed for computing.
Each has attempted to adjust to a new world where off-site cloud storage is quickly becoming the norm. Microsoft has been the most successful in this paradigm because the company modified its business model to subscription-based billing and worked to expand its service and presence in the cloud. IBM continues to struggle but recently posted a better-than-expected quarter. Cisco is no different; its new Catalyst 9000 enterprise switches show that the company is attempting to move from hardware-focused network solutions to software-focused subscription-based services.
In the quarter, recurring-based sales comprised 32% of total revenue, an increase of 3 percentage points from last year. Cisco CEO Chuck Robbins summed up the results by saying, "Our strategy is working." Look for a continued shift to services and software as Cisco recently announced its intentions to purchase BroadSoft, a cloud-based collaboration provider, to expand its capabilities.
Cisco appears cheap, but is it a mirage?
On the surface, Cisco appears cheap when compared to the S&P 500. Shares currently trade at a forward price to earnings ratio of 14 versus the S&P's 21 times multiple. Additionally, the company now has a 3.1% yield, which is easily supported by free cash flow. The issue is growth: Revenue has declined each of the last eight quarters. On a positive note, management expects next quarter to reverse that trend, guiding for revenue growth of 1% to 3%.
Looking beyond the next quarter, Cisco's big opportunities are to continue to wisely acquire fast-growing companies to expand its cloud-based presence and to continue to offer network infrastructure solutions to the nascent Internet of Things. If the company can execute on both fronts, it's likely the stock is highly undervalued.
Unfortunately, it's difficult to recommend a company dependent upon acquisitions as most fail to add value. Additionally, while I think the Internet of Things will be a positive tailwind for Cisco, the company is essentially a "pick and shovel provider" and is mostly dependent on other businesses or governments to embrace the technology, which presents timing risk. I'm holding off on pulling the trigger but will be watching next-quarter's earnings report closely.
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Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Jamal Carnette, CFA has no position in any of the stocks mentioned. The Motley Fool recommends Cisco Systems. The Motley Fool has a disclosure policy.