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Better Buy: Sierra Wireless vs. Cisco

By Leo Sun - Nov 29, 2019 at 12:00PM

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Both companies are underperforming the market, but one is clearly the stronger buy.

Sierra Wireless ( SWIR -0.32% ) and Cisco ( CSCO -2.00% ) both play crucial roles in connecting devices across the world. Sierra is the world's leading provider of M2M (machine-to-machine) modules and gateways, and Cisco is the top manufacturer of networking switches and routers.

I compared these two companies in March, and concluded that Cisco's better diversified business and dividend, along with its cheaper valuation, made it the better investment. Unfortunately, neither stock outperformed the market since that article was published -- Cisco's stock dropped 14% as Sierra's stock tumbled over 30%.

Network connections across a city.

Image source: Getty Images.

Today we'll take a look back at why both companies struggled, and whether or not Cisco is still a stronger overall investment than Sierra Wireless.

What happened to Sierra Wireless?

Sierra splits its business into two main units. Its IoT (Internet of Things) unit generated 54% of its revenue last quarter. The rest came from its embedded broadband business, which has been struggling with soft demand from the mobile device, networking, and automotive markets over the past few quarters.

Sierra's acquisition of Numerex at the end of 2017 significantly boosted its IoT and total revenue throughout 2018. However, sales fell year-over-year for three straight quarters as the macro headwinds strengthened. Its gross margins also gradually contracted.

Sierra Wireless

Q3 2018

Q4 2018

Q1 2019

Q2 2019

Q3 2019

YOY revenue growth

18%

10%

(7%)

(5%)

(14%)

Gross margin*

33.1%

32.7%

31.5%

30.8%

31.7%

YOY = Year-over-year. *Non-GAAP. Source: Sierra Wireless quarterly reports.

Sierra expects its IoT revenue to rise 3%-4% for the year, but it also expects its embedded broadband revenue to decline 22%-23%, which will result in an 11% drop in revenue (at the midpoint) for the full year. Analysts expect its revenue to rise 1% next year.

Servers in a data center.

Image source: Getty Images.

What happened to Cisco?

Cisco generated 57% of its revenue from infrastructure platforms (like routers and switches) last quarter; 17% came from its higher-growth applications and security divisions, which often bundle software products with its hardware; and 25% of its revenue came from its services unit.

Cisco's revenue growth decelerated over the past year, as weaker demand for hardware upgrades from service providers (especially in emerging markets) offset its higher hardware sales to data center and enterprise campus customers. However, Cisco's gross margins still gradually expanded, indicating that the cyclical slowdown wasn't hurting its pricing power.

Cisco Systems

Q1 2019

Q2 2019

Q3 2019

Q4 2019

Q1 2020

YOY revenue growth

8%

7%

6%

6%

2%

Gross margin*

63.8%

64.1%

64.6%

65.5%

65.9%

YOY = Year-over-year. *Non-GAAP. Source: Cisco quarterly reports.

Nonetheless, Cisco expects its revenue to decline 3%-5% year-over-year in the second quarter, which would break its two-year streak of rising revenue. Analysts expect its revenue to dip 2% for the full year.

Which stock is cheaper relative to its earnings growth?

Sierra hasn't been consistently profitable over the past year, and Wall Street expects a whopping 98% drop in earnings this year before it returns to growth next year.

Sierra is currently cutting costs and reinvesting the cash into next-gen 5G and LPWA (low-power wide area network) modules. Those investments, along with the continued growth of the 5G and IoT markets, could pave the way toward a cyclical recovery, but they probably won't bear fruit until next year. Meanwhile, Sierra's stock doesn't look cheap at over 40 times forward earnings, and it doesn't pay a dividend to investors who are willing to ride out the near-term headwinds.

Cisco is consistently profitable and buoys its EPS growth with big buybacks. That's why analysts expect its earnings to rise 5% this year even as its revenue declines.

Cisco needs to work through some issues, especially its weakness in the service provider market and China (where it's barred from big government bids), but it will likely remain the 800-pound gorilla in the networking hardware market for the foreseeable future. Its stock looks fairly cheap at 13 times forward earnings, and its forward yield of 3.1% might lock in more income investors.

Cisco is still the better buy

Cisco admittedly wasn't a great investment over the past year, but it fared much better than Sierra Wireless. That trend will likely continue for at least a few more quarters, so investors should stick with Cisco, collect its dividend, and await a cyclical recovery instead of jumping the gun on Sierra's gradual comeback.

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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Stocks Mentioned

Cisco Systems, Inc. Stock Quote
Cisco Systems, Inc.
CSCO
$56.92 (-2.00%) $-1.16
Sierra Wireless, Inc. Stock Quote
Sierra Wireless, Inc.
SWIR
$16.98 (-0.32%) $0.06

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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