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Why Cisco's Weak Guidance Creates an Opportunity for Dividend Investors

By Herve Blandin - Nov 20, 2019 at 12:00PM

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The yield now exceeds 3.1% -- and it's safe.

Cisco's ( CSCO 0.14% ) fiscal first-quarter results surpassed expectations, but investors worry about the forecast for a next-quarter revenue decline after two years of growth. As a result, the stock price dropped below $45 and the dividend yield now exceeds 3.1%. The negative market reaction provides an opportunity to invest in this tech stock that pays a safe dividend.

Strong fiscal first-quarter results, but weak guidance

Cisco's revenue growth of 2% reached the top end of management's guidance range of 0% to 2%. But keep in mind Cisco's tricky reporting: The company excludes divested assets, which provides shareholders with a fair year-over-year comparison. However, it doesn't exclude the contribution from its acquisitions, which provides rosier revenue growth compared with its organic growth (i.e., without acquisitions). Without the acquisitions, year-over-year revenue would have increased by 1.5% only.

The infrastructure platforms segment -- core networking technologies such as switching, routing, and wireless products -- dropped by 1% year over year. Management indicated only routing declined and, once again, service providers caused this underwhelming performance. But the two other product segments -- applications and security -- increased by 6% and 22%, respectively. And services, up 4% year over year, also contributed to the total revenue growth.

Cisco's transition to software and its strong revenue growth pushed margins above management's guidance, as shown in the table below. 

Metrics (Non-GAAP) Guidance Fiscal First-Quarter Results
Gross margin 64% to 65% 65.9%
Operating margin 32% to 33% 33.6%
Earnings per share  $0.80 to $0.82 $0.84

Data source: Cisco. GAAP = generally accepted accounting principles.

The weak guidance was the highlight of Cisco's fiscal first-quarter results, though. 

Management expects revenue to decline by 3% to 5% in the next quarter. Considering the tough comparison with the previous year's revenue growth of 7%, the guidance doesn't seem that alarming. Also, management still expects a high operating margin in the range of 32.5% to 33.5%.

But what's more worrisome is that management said that the broad-based weakness, across technologies and geographies, was showing no sign of improvement over the short term. This pessimistic forecast reflects the disappointing guidance the peer network vendor Arista Networks communicated during its latest earnings call.

IT technician with a laptop computer and engineer colleague are talking in data center while walking next to server racks.

Image source: Getty Images.

A safe dividend

Given the weak outlook, Cisco's stock price dropped by 7.33% the day after its earnings, increasing the dividend yield to 3.12%. And given Cisco's strengths, the payout is becoming attractive for dividend investors.

Despite the lack of positive signs over the next few quarters, the company will profit from several tailwinds in the longer term. Both 5G and 400G technologies are going to ramp up in the next several years, which may explain the current weakness with service providers that postpone some investments.

The 5G technology allows service providers to use their existing core infrastructure that supports their 4G network while deploying 5G antennas. This flexibility facilitates the transition to 5G, but it also involves reduced spending from service providers before they transition their core network into the full 5G technology. As for 400G, the timing of its deployment depends on the availability of optics -- small adapters that connect network devices to fiber -- at scale, in about one year.

But even if these developments materialize with some delay, Cisco's dividend remains safe. The quarterly dividend represents an annual cash outflow of $5.94 billion. In comparison, the company generated a much higher free cash flow of $11.57 billion over the last 12 months. And if you prefer to rely on GAAP accounting, the quarterly dividend of $0.35 per share stays well below the company's fiscal first-quarter GAAP earnings per share of $0.68.

Besides, the net cash position of $9.5 billion at the end of its latest quarter gives Cisco plenty of flexibility to pay its dividend, acquire other companies, and repurchase its shares. 

Looking forward

With the drop in the stock price because of the disappointing guidance, dividend investors should consider Cisco as an attractive tech stock. The dividend is sustainable since it represents slightly more than half of the company's free cash flow and GAAP earnings per share. And Cisco's short-term challenges will wane when the tailwinds of new technologies such as 5G and 400G materialize, which will give management the opportunity to increase the dividend. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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