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How Safe Is Cisco and Its Dividend?

By Herve Blandin - May 15, 2020 at 11:00AM

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Fiscal third-quarter results showed the old tech giant is facing challenges amidst the coronavirus-induced uncertainties.

Cisco Systems(CSCO 1.74%) year-over-year revenue decline accelerated during the last quarter, and management expects this trend to continue over the next one. Should investors worry about a potential secular deterioration of the old tech giant's businesses, which could threaten its juicy dividend beyond the short term?

Declining revenues

As several billion people have been staying at home over the last couple of months to try to limit the spread of COVID-19, several tech companies have disclosed a significant surge in the use of their cloud-based products and services over that time frame. Looking forward, the adoption of cloud computing may accelerate as employees and enterprises have been experiencing this flexible way of working.

Cisco offers on-premises and cloud collaboration, networking, and cybersecurity solutions that address the needs of on-site and remote workers. But in contrast with many high-growth cloud-based companies, the old tech giant posted a year-over-year revenue drop of 8% during its fiscal third quarter, down to $12.0 billion. And management forecasted next-quarter revenue to decline to a range of 8.5% to 11.5% because of coronavirus-induced challenges.

The shrinking top line looks worrying as the company didn't seem to have benefited from the increase in demand for networking and software solutions to facilitate remote working.

During the earnings call, CFO Kelly Kramer explained that Cisco's largest segment, infrastructure platform (mostly networking hardware and software), dropped 15% year over year to $6.4 billion because of supply chain issues. 

In addition, the company's weak results also materialized in other segments that were not exposed to supply chain difficulties.

As an illustration, despite the surge in consumption in the company's cloud communication and collaboration solution Webex, its application segment dropped by 5% to $1.4 billion because of the decline of its legacy communications platform.

Cisco's security segment also grew by only 6% year over year to $776 million despite the double-digit growth of its cloud-based security products Duo and Umbrella. In comparison, last week the cybersecurity specialist Fortinet posted a strong first-quarter revenue growth of 22% to $577 million as it took advantage of the increasing demand to secure remote workers' computing environments.

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

Image source: Getty Images.

The long term looks brighter

Cisco's top line should improve when the coronavirus situation settles, though.

During the earnings call, CEO Chuck Robbins discussed how many companies realized their computing infrastructures were outdated as they struggled to provide remote working capabilities to their employees, which should boost the demand for Cisco's networking solutions in the medium term.

Extra revenue from Webex has yet to materialize as Cisco prioritized business continuity with its existing and new customers, allowing them to consume more licenses than they purchased and proposing 90-day free offerings.

In addition, Cisco remains exposed to the secular long-term growth opportunities new technologies such as 5G and 400G (high-speed networks) represent.  

A safe dividend

Even during this challenging fiscal third quarter, margins remained strong thanks to the company's huge scale: Operating margin under generally accepted accounting principles (GAAP) reached 28.5%, up from 27.1% one year ago. GAAP net income dropped to $2.8 billion, down from $3.0 billion last year, but it still covers Cisco's quarterly $1.5 billion dividend by a wide margin. 

And with $12.5 billion of cash, cash equivalents, and investments in excess of total debt at the end of last quarter, the dividend, which yields 3.3%, seems safe.

In fact, in contrast with many companies that suspended their share repurchase programs to protect their dividends amid coronavirus uncertainties, Cisco bought back 25 million shares for $981 million during the last quarter thanks to its strong balance sheet. The company also took advantage of its comfortable financial position by offering a $2.5 billion financing plan to strengthen its customer relationships through the coronavirus crisis.

Beyond the safe dividend, Cisco's valuation should trigger the attention of prudent investors. Based on the midpoint of management's forecasted fiscal fourth-quarter GAAP earnings, the market values the tech stock at a reasonable price-to-earnings (P/E) ratio of 16. 

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