Cisco Q2 2021 Earnings Review

Cisco Systems posted their Q2 2021 earnings this week. Earnings came in ahead of estimates yet the share price tumbled 5% after hours.

I already hold a small position in $CSCO but Is this an opportunity to buy this dividend contender?

Cisco Earnings Highlights

“We are seeing encouraging signs of strength across our business showing how our technology will be a powerful engine for recovery and growth,”  

Chief Executive Chuck Robbins

I am always amazed at how CEOs manage to find positives in almost any situation. I don’t really share Chuck Robbin’s view that we saw signs of strength. It wasn’t all bad news so I will share some of the positives below.

• Cisco saw a double-digit year on year increase in deferred product revenue for the 6th consecutive quarter
• Achieved $3.6B in software revenue with 76% of revenue sold as a subscription.
•  Beat earnings by 3.95%
• Increase dividend by 3% to 37 cents per common share.

A dividend raise is always welcome especially when they are well covered by Free CashFlow. The FCF payout ratio stands at roughly 40%. While a 3% raise is below my desired rate, it is understandable in the current climate.

If Cisco beat earnings and increased the dividend – Why did the share price drop?

CISCO Earnings Financial Results

Total revenue fell to $11.96 billion from $12.01 billion YoY. This was the 5th consecutive Quater where we have seen a decline in revenue. Infrastructure sales declined 3% to $6.39 billion and applications sales were flat at $1.35 billion, while security sales rose 10% to $822 million from the year-ago period.

A large portion of Cisco’s revenue comes from purchases of network hardware by government agencies, corporations, and phone service providers. The Enterprise business accounts for about 50% of sales but this has been impacted by the shift to working from home during the pandemic. In November Cisco indicated that corporations and governments were beginning to resume spending. This may not be happening as quickly as expected as the segment is down 9% YoY.

“Cisco executed well in Q2, delivering growth in orders, strong margins, and growth in non-GAAP EPS, while continuing to grow deferred revenue in double-digits through the shift to more software and subscriptions”

Scott Herren, CFO

It is no surprise to see the CFO mention net income and earnings on a non-GAAP basis where they show an increase YOY. Adjusted earnings, which exclude stock-based compensation expenses, were $0.79, compared with $0.77 cents a share YoY. However, it is important to consider Stock-based compensation as a real expense. On a GAAP basis, they reported a net income (GAAP) of $2.55 billion, or 60 cents a share which is down 12% from the year before.

Cash Flow from Operating Activities was down 22% to $3.0 billion from $3.8 billion in the second quarter of fiscal 2020. They are also sitting on $30.6 billion in cash which is up from $29.4 billion.

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Acquisitions

Cisco is continuing their aggressive acquisition strategy. since 2019 they have acquired or announced their intent to acquire 15 companies. How successful these acquisitions are is remained to be seen but the Slido, BabbleLabs,Voicea were bought to complement Webex and win back market share from Google,Microsfott and Zoom.

They also announced an amendment to the agreement to acquire Acacia Communications, a public fabless semiconductor company. Under the terms of the amended agreement, Cisco would acquire Acacia for $115 per share for approximately $4.5 billion on a fully diluted basis. This is up from $2.9 Billion that was initially agreed as in 2019.

Guidance for Q3 2021

Cisco expects better earnings in Q3 2021 and to return to growth. They expect revenue to increase between 3.5 and 5.5% YoY and GAAP EPS to be $0.69.

My Personal Thoughts

Reading Cisco’s earnings, left me feeling a little underwhelmed. A 5th consecutive drop in Quarterly revenue can not be purely be blamed on Covid-19. I can agree that excuses can be made for the decline in infrastructure revenue throughout the pandemic but I would have expected applications to perform a little bit better.

My issue is that I am failing to see a solid catalyst for this company! What is going to drive future growth? European DGI discussed how to spot a company in decline in one of our recent podcasts. Are Cisco beginning to show early signs?

With the pandemic going on for as long as it has and working from home becoming the new normal, How will this impact Cisco in the long run? In fact, in My own country, they are making it a right to seek permanent remote work. While it is still early stages, it is not hard to imagine this becoming the new normal within the next 10/20 years.

Cisco had long been a market leader when it came to security even though it is one of their smaller segments. In this market, they have now been eclipsed by Palo Alto Networks. In the second quarter of 2020, Cisco’s market share in the security appliance market stood at 17 percent, whilst Palo Alto Networks occupied 18.1 percent of the market.

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Future growth

The main potential driver for growth in my opinion will come from acquisitions. Over the last number of years, we have seen a clear pivot from hardware to software with acquisitions. Cisco acquired Duo Security for $2.35 billion in 2019. Cisco purchased SD-WAN companies Meraki in 2012 and Viptela in 2017.  They also announced an amendment to the agreement to acquire Acacia Communications, a public fabless semiconductor company that they hope to close out in 2021. They also announced intent to acquire IMImobile PLC, a United Kingdom publicly-traded cloud communications software and services company.

As we have seen with other large-cap companies in transition such as Intel, it is never a smooth ride. they aim to increase recurring revenue from subscription-based software and services and shift away from its core business of selling network switches and routers. This is the first Quarter that they have reported software sales separately where it accounted for 33% of the revenue.

Fundamental analysis

Using my Fundamental analysis template Cisco scored 69 out of 100 for financial strength and 79 out of 100 for Dividend Safety.

Looking over the past 5 years revenue has been almost flat while EPS has grown 8.57% in the same period. This is mainly due to share buybacks with over $42Billion repurchased over the number of years. This has slowed down a bit but and still have $9.2 billion left on the current buyback program. They have really strong profit margins and the dividend is well covered. Debt is low and interest is more than covered. They look to be fairly valued with the drop in the last couple of days.

Is Cisco a buy?

Usually I would buy a company like cisco. Flatlining Revenue is a red flag but almost all other metrics meet my requirements and they have a solid balance sheet.

My problem is that when I look into the future, I don’t know where the growth will come from apart from acquisitions. The expectation for Cisco around 5G is high but I am not yet seeing enough at the moment. At the moment I would like to see Cisco return back to growing again before I consider buying them.

if you are looking for ideas on who to consider then check out these 3 compelling high dividend companies.

If you would like a copy of the template I use to to perform stock analysis than feel free to grab your copy below.

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