Cisco (CSCO) Makes a Strong Comeback and Tops Earnings Estimates

This week, networking equipment maker Cisco (CSCO: Charts, News) topped Wall Street's second quarter forecasts on both profit and sales, with adjusted earnings of 47 cents per share on revenue of $11.5 billion. Analysts on average were expecting earnings of 45 cents on revenue of $11.2 billion.

This marks Cisco's fourth consecutive quarter of rising revenues, and breaks four consecutive quarters of profit declines. This is also the fourth straight quarter that Cisco has beat the street.

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Investors had been concerned that delays in network upgrades by telecom companies would dampen its revenue, but the company attributed its strong earnings to CEO John Chambers's aggressive turnaround plan which started last year. Chambers cut thousands of jobs, streamlined a cumbersome internal decision-making hierarchy, eliminated unprofitable business segments and focused on more profitable ones. Chambers attributed the company's strong numbers to the success of his turnaround measures, stating that Cisco achieved a "billion-dollar expense reduction a quarter early - and our ongoing innovation enables our customers to solve their critical business needs."

The San Jose, California-based company also decreased its average product price, sacrificing margins in order to gain more sales volume from its competitors. Gross margins eroded to 61.3%, a slow decline from the 65% it posted two years ago, while orders from service providers grew 12%, reflecting this new shift in strategy. Cisco has targeted lower priced competitors such as Hewlett-Packard (HPQ: Charts, News), Juniper (JNPR: Charts, News) and Huawei Technologies, which have stolen the company's market share over the past several years. Despite lower prices, Cisco's other cost-cutting measures have apparently kept its bottom line well-protected. Its price-cutting aggression is well documented in the industry. A January survey by Robert W. Baird & Co. of 100 resellers of Cisco products found that over half claimed that Cisco had become "incrementally more aggressive on pricing in the past few months."

Although many analysts hesitate to call Cisco's solid quarter a "turnaround", shares have already risen 13% for the year, as investors anticipate higher orders and upgrades of networking equipment as the global economy recovers from the stagnation of 2011. The stagnation has been exacerbated by an increasingly fragmented market of networking equipment makers. A third of Cisco's revenue comes from service providers, which is less than its industry peers. This has insulated it from a slowdown in network upgrades at the big telecom companies that has hurt its rivals, such as Juniper, which earns over half of its revenue from that market. In addition, Cisco not only posted growth in its routers business, but also in its Enterprise, Commercial, Search and Cloud-based businesses as well.

Looking forward, Cisco projects adjusted third quarter earnings between 45 and 47 cents per share on revenue between $11.4 to $11.6 billion. This is in line with the 45 cents per share on revenue of $11.5 billion that analysts on average had predicted. Several analysts had stated that the guidance, while in line, was too conservative, and that Cisco needed to guide higher to keep the shares rallying. However, the company may be wise to set the bar lower for next quarter so it can beat its own estimates with ease. Cisco also raised its quarterly dividend from 6 to 8 cents per share. Due to its diverse customer base, Cisco - a Dow component - is widely regarded as a bellwether for the tech sector as well as the global economy. Shares currently trade at 10.6 times forward earnings with a 5-year PEG ratio of 1.4, both bullish signals for a patient value investor. The company is by far the largest in the industry, with a market cap of $110 billion.

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Published on Feb 10, 2012
By Leo Sun
Leo Sun
Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.

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