Cisco Systems Inc: Buy Trade – Position Open July 16, 2018 1066

Description

Cisco System Inc. (NASDAQ:CSCO) designs and sells a range of products, services and integrated solutions to develop and connect networks around the world. CSCO groups its products into various categories such as Switching, Next Generation Network Routing, Collaboration, Data Center, Wireless, Service Provider Video, Security and Other Products.

Source: Thomson Reuters

Company Highlights

  • CSCO most lucrative product is Switching, accounting for over USD13.9bn in 2017
  • CSCO is the global market leader in Ethernet switches with 55% market share
  • CSCO is also 5th largest vendor of servers based on revenue

Investment Rationale

CSCO’s new growth plans have been bearing fruit, leading the share price to re-rate from USD34.00 two quarters ago, to its 52 week high of USD46.34. Its CEO has been transitioning the company into a stronger player in software, away from its traditional hardware roots, as well as to a subscription-based model. As a result, revenue has been growing steadily for the past few quarters, with the latest quarter registering a revenue growth of 4%, with 32% of revenue from recurring sources, up 2% YoY.  However, recent news that Amazon (NASDAQ:AMZN) intends to compete by releasing their own Switching hardware has caused CSCO to plunge over 4%. However, we believe that the fears are overblown and CSCO remains in a strong position. As such, we believe that the drop in prices represents a buying opportunity for CSCO.

Our Reasons for Buying CSCO

1. Recent Price Action: CSCO has been on a strong uptrend since Nov 2017. However, its prices recently took a hit due to news from AMZN. Its price came close to its 200 day moving average of USD40.59 before pulling back to close at USD41.78. We believe that this represents a buying opportunity for CSCO.

2. Competition from Amazon: On 13th July 2018, Amazon Web Services was reported to be considering selling its own network switching devices. Additionally, they are expected to price them at a 70 to 80% discount to CSCO’s hardware. This led to shares of other companies in the network switching space to fall, with CSCO dropping more than 4%, Arista Networks (NYSE:ANET) also fell more than 4%.

Network switches make it easier to shepherd traffic around networks. AWS has been using its own internally designed networking gear in its own data centers, which are “white-box” devices. In layman terms, these devices can be considered to be “open source” and can be powered by off the shelf switching chips, and can run a variety of switch operating systems. The switches from CSCO on the other hand, tend to run proprietary operating systems and in some cases, powered by proprietary switching ASICs.

Firstly, switching hardware and software account for slightly more than a third of product revenue in 2017. Additionally, AWS’s switching devices will be primarily targeted towards data centers, which while a significant portion of revenue, is not a majority of the revenue from Switching for CSCO.

Secondly, while the “white box” switches may be more popular for cloud operators or other software developers due to their “open source” nature, which allows companies to customize and design their own operating systems, more traditional enterprises may not be as open to them despite the cheaper prices. As these switches tend to come with little to no software, companies without a significant IT department or with no desire to devote resources to developing and managing their own OS may still choose to purchase switches from an established vendor such as CSCO. As an example, Linux is a free, open source and more flexible operating system compared to Microsoft, however, Microsoft still has a far more dominant market share as most companies prefer not to devote resources to develop or customize their own software. As a result, we believe that fears of competition from AMZN are overblown and the actual impact to CSCO will be minimal.

3. Company Transition: In 2015, CSCO’s current CEO, Chuck Robbins, took over as the company was suffering from stagnating revenue. He set into motion a transition plan for CSCO, moving the company from its legacy hardware business to more software focused business. CSCO released Internet-based network solutions, which focused more on software networking, improved security and artificial intelligence adoption. The company also started its transition away from reliance on hardware products for revenue towards a more subscription-based model to create a more predictable revenue stream. Such subscription-based models have proven beneficial to growth of companies, as can be seen from Microsoft’s adoption on its share price.

4. Valuations: CSCO closed at USD41.78 and trades at a forward PER of 16.10. CSCO’s 5-year average PER is 15.62. CSCO’s total revenue for 2017 was USD48.00bn. CSCO has been able to generate a free cash flow of USD12.91bn for FY17 and has been able to consistently grow free cash flows, up from USD12.42bn in FY16 and USD11.33bn in FY15. CSCO has been able to keep its expenses low, resulting in a very impressive 96% gross margin in FY17, up from 62.87% in FY16 and 60.38% in FY15. CSCO also pays a dividend yield of 2.97%, with a dividend payout ratio of 0.59. CSCO has been consecutively growing their dividends for the past 7 years, with a 5-year average growth of 26.40%. Given CSCO’s strong financials and potential growth prospects, we believe that the current pull back in price represents a buying opportunity.

Conclusion: We believe that the recent pullback in price due to news of potential competition from AMZN to be overblown. The potential impact to CSCO from AMZN’s offerings is likely to be minimal. Further, CSCO has been transitioning away from its legacy hardware business to a more software oriented as well as subscription-based model. As such, we believe that the recent fall in prices to represent a buying opportunity and we are bullish on CSCO due to 1) Company’s transition plans and 2) Valuations given CSCO’s growth prospects.

Important Information

This report is prepared and/or distributed by Phillip Securities Research Pte Ltd ("Phillip Securities Research"), which is a holder of a financial adviser’s licence under the Financial Advisers Act, Chapter 110 in Singapore.

By receiving or reading this report, you agree to be bound by the terms and limitations set out below. Any failure to comply with these terms and limitations may constitute a violation of law. This report has been provided to you for personal use only and shall not be reproduced, distributed or published by you in whole or in part, for any purpose. If you have received this report by mistake, please delete or destroy it, and notify the sender immediately.

The information and any analysis, forecasts, projections, expectations and opinions (collectively, the “Research”) contained in this report has been obtained from public sources which Phillip Securities Research believes to be reliable. However, Phillip Securities Research does not make any representation or warranty, express or implied that such information or Research is accurate, complete or appropriate or should be relied upon as such. Any such information or Research contained in this report is subject to change, and Phillip Securities Research shall not have any responsibility to maintain or update the information or Research made available or to supply any corrections, updates or releases in connection therewith.

Any opinions, forecasts, assumptions, estimates, valuations and prices contained in this report are as of the date indicated and are subject to change at any time without prior notice. Past performance of any product referred to in this report is not indicative of future results.

This report does not constitute, and should not be used as a substitute for, tax, legal or investment advice. This report should not be relied upon exclusively or as authoritative, without further being subject to the recipient’s own independent verification and exercise of judgment. The fact that this report has been made available constitutes neither a recommendation to enter into a particular transaction, nor a representation that any product described in this report is suitable or appropriate for the recipient. Recipients should be aware that many of the products, which may be described in this report involve significant risks and may not be suitable for all investors, and that any decision to enter into transactions involving such products should not be made, unless all such risks are understood and an independent determination has been made that such transactions would be appropriate. Any discussion of the risks contained herein with respect to any product should not be considered to be a disclosure of all risks or a complete discussion of such risks.

Nothing in this report shall be construed to be an offer or solicitation for the purchase or sale of any product. Any decision to purchase any product mentioned in this report should take into account existing public information, including any registered prospectus in respect of such product.

Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may provide an array of financial services to a large number of corporations in Singapore and worldwide, including but not limited to commercial / investment banking activities (including sponsorship, financial advisory or underwriting activities), brokerage or securities trading activities. Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may have participated in or invested in transactions with the issuer(s) of the securities mentioned in this report, and may have performed services for or solicited business from such issuers. Additionally, Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may have provided advice or investment services to such companies and investments or related investments, as may be mentioned in this report.

Phillip Securities Research or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report may, from time to time maintain a long or short position in securities referred to herein, or in related futures or options, purchase or sell, make a market in, or engage in any other transaction involving such securities, and earn brokerage or other compensation in respect of the foregoing. Investments will be denominated in various currencies including US dollars and Euro and thus will be subject to any fluctuation in exchange rates between US dollars and Euro or foreign currencies and the currency of your own jurisdiction. Such fluctuations may have an adverse effect on the value, price or income return of the investment.

To the extent permitted by law, Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may at any time engage in any of the above activities as set out above or otherwise hold an interest, whether material or not, in respect of companies and investments or related investments, which may be mentioned in this report. Accordingly, information may be available to Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, which is not reflected in this report, and Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited to its officers, directors, employees or persons involved in the issuance of this report, may, to the extent permitted by law, have acted upon or used the information prior to or immediately following its publication. Phillip Securities Research, or persons associated with or connected to Phillip Securities Research, including but not limited its officers, directors, employees or persons involved in the issuance of this report, may have issued other material that is inconsistent with, or reach different conclusions from, the contents of this report.

The information, tools and material presented herein are not directed, intended for distribution to or use by, any person or entity in any jurisdiction or country where such distribution, publication, availability or use would be contrary to the applicable law or regulation or which would subject Phillip Securities Research to any registration or licensing or other requirement, or penalty for contravention of such requirements within such jurisdiction.

This report is intended for general circulation only and does not take into account the specific investment objectives, financial situation or particular needs of any particular person. The products mentioned in this report may not be suitable for all investors and a person receiving or reading this report should seek advice from a professional and financial adviser regarding the legal, business, financial, tax and other aspects including the suitability of such products, taking into account the specific investment objectives, financial situation or particular needs of that person, before making a commitment to invest in any of such products.

This report is not intended for distribution, publication to or use by any person in any jurisdiction outside of Singapore or any other jurisdiction as Phillip Securities Research may determine in its absolute discretion.

IMPORTANT DISCLOSURES FOR INCLUDED RESEARCH ANALYSES OR REPORTS OF FOREIGN RESEARCH HOUSE

Where the report contains research analyses or reports from a foreign research house, please note:

  1. recipients of the analyses or reports are to contact Phillip Securities Research (and not the relevant foreign research house) in Singapore at 250 North Bridge Road, #06-00 Raffles City Tower, Singapore 179101, telephone number +65 6533 6001, in respect of any matters arising from, or in connection with, the analyses or reports; and
  2. to the extent that the analyses or reports are delivered to and intended to be received by any person in Singapore who is not an accredited investor, expert investor or institutional investor, Phillip Securities Research accepts legal responsibility for the contents of the analyses or reports.
Subscribe
Notify of
guest
0 Comments
Inline Feedbacks
View all comments

About the author

Profile photo of Ho Kang Wei

Ho Kang Wei
Investment Analyst
Phillip Securities Research Pte Ltd

Ho Kang Wei graduated with a Bachelor of Commerce, majoring in Accounting and Finance, from Monash University.

He started analysing and investing in US equity markets since 2008. Joining Phillip Securities Research in 2015, he is the analyst in charge of US markets.

Get access to all the latest market news, reports, technical analysis
by signing up for a free account today!