Cisco Systems (CSCO): The Networking Giant Is A Buy

Cisco Systems (CSCO), the networking giant, has the distinction of one-time having the largest market capitalization. During the dot-com boom Cisco reached a peak valuation of approximately $555.4 billion. The company’s stock price plummeted after the dot-com boom and it still has yet to reach the highs of that era. However, it is still the world’s largest vendor of networking hardware and software. The company is highly profitable and generates prodigious cash flow.  This has translated into robust share buybacks and a growing dividend. The current yield is roughly 3.4%. Further, Cisco’s balance sheet is rock solid. That said, the recent quarterly results and outlook were poorly received by the market. The stock price is down about 12% year-to-date and trading where it was in early-2018. I view the Cisco, the networking giant, as a long-term buy for those seeking income and dividend growth.

Overview of Cisco – The Networking Giant

Cisco is world’s largest Internet Protocol networking company. The company was founded in 1984. The company operates in three business segments: Infrastructure Platforms Group, Security Segment, and Services. Today, the company sells hardware and software for switching, routing, data centers, and wireless applications. Cisco also sells software for networking, analytics, collaboration, and security and firewalls. The company is ranked 15 in the 2019 Interbrand’s Best Global Brand list. Cisco had $49,301 million of revenue in 2019.

COVID-19 Is Hurting Demand

Cisco recently reported decent Q4 2020 results but with a weak outlook. Additionally, the company announced that the CFO was retiring. The stock price plunged nearly 12% in response. It was the largest decline in almost 11 years. However, the negative outlook was largely due to the impact of COVID-19. Many businesses are reducing spending across the board to preserve liquidity and maintain cash flow. This led to weak demand of Cisco’s Infrastructure Platform products. However, many businesses now have higher demand on their networks due to telecommuting during the coronavirus pandemic. They will eventually need to upgrade their networks to handle this change. Cisco should be a beneficiary.

Cisco the Networking Giant Faces Competition Everywhere

The major risk for Cisco is that it is in very competitive end markets. In the infrastructure market other major players include Arista Network (ANET), Juniper Networks (JNPR), Aruba Networks [Owned by Hewlett Packard Enterprises (HPE)], Huawei, and smaller privately held companies. Other companies that compete with Cisco in software or security include Palo Alto Networks (PANW), Checkpoint Technologies (CHKP), Fortinet (FTNT), F5 Networks (FFIV), FireEye (FEYE), and others. The list of competitors is even longer as many other companies compete in certain focused areas.  However, few companies have the scale and breadth of Cisco. The company has positioned itself as a vendor of more comprehensive or complete solutions for networking requirements.

Cisco Income and Dividend Growth

As a dividend growth stock Cisco is a relatively new player. The company has raised the dividend for 9 consecutive years making Cisco a Dividend Challenger. This is not a long time when compared to some conventional choices for dividend growth stocks. But the rate of dividend increase has been rapid from a quarterly regular cash dividend of $0.06 in 2011 to $0.36 in 2020. The compound annual growth rate or CAGR has been slightly over 13% in the past 5-years.

Cisco pays an annual forward dividend of $1.44 and is yielding approximately 3.4% as of this writing. The current yield is almost double the roughly 1.75% yield offered by the S&P 500 index. The combination of a consistently rising dividend and decent yield should interest most investors seeking income or dividend growth.

Cisco’s trailing dividend safety metrics are excellent. In fiscal 2020, the payout ratio was approximately 54%. The dividend was also well covered by free cash flow. In fiscal 2020, operating cash flow was $15,426 million and capital expenditures were $770 million giving free cash flow of $14,656 million. The dividend required $6,016 million giving a dividend-to-FCF ratio of 41%. I used TIKR* to obtain this data. Debt is not an issue from the perspective of the dividend as Cisco has a net cash position. Importantly total debt has declined over the past few years.

Cisco’s Valuation

Cisco is undervalued at the moment due to the negative outlook. The stock is trading at about 13.7X consensus fiscal 2021 earnings of $3.09 per share. This is well below the earnings multiple of the S&P 500, which is trading at nearly 30X earnings. The Gordon Growth Model gives a fair value estimate of $48 assuming an 8% return and 5% dividend growth. Cisco is also on the Dogs of the Dow list for 2020. In an arguably overvalued market, Cisco offers income and dividend growth at a reasonable valuation. Cisco is a networking giant that is the market leader. I view the stock as a long-term buy.

Disclosure: Long CSCO

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