Cisco Systems (CSCO 0.26%), like many companies this year, reported a year-over-year revenue decline -- in this case, for its third quarter ended April 25. Few can expect to avoid the economic impact of the coronavirus pandemic.
But not all of Cisco's revenue drop is attributable to the pandemic. The company's stock hit a 52-week high of $58.26 on July 16 last year, but soon after, Cisco reported a slowdown in business due to macroeconomic factors such as the trade war with China. The stock has remained consistently below $50 since then, and hovers around $45 as of this writing.
So is now the time to buy Cisco? A deep dive into the company can answer that question.
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Company challenges
As clients adjusted IT spending due to the pandemic, Cisco experienced an 8% year-over-year revenue decline in the quarter. This followed the prior quarter's 4% revenue drop as a result of macroeconomic factors, including the cyclical nature of Cisco's computer networking hardware business. This part of Cisco, which falls under its infrastructure platforms segment, accounted for $6.4 billion of its $12 billion total third-quarter revenue.
Other forces are at work as well. The trade war with China hurt the company, but a more-permanent challenge to its future is the IT industry trend toward the use of white boxes, the generic versions of Cisco's brand-name computer networking hardware.
In addition, the advent of cloud computing means Cisco's clients can use cloud services to support technology infrastructure, eliminating the need for networking hardware. This explains the third-quarter year-over-year decline of 15% in Cisco's infrastructure platforms division, which follows an 8% decline in Q2.
The upsides
Cisco expanded into software products to diversify its business, and has done well. In 2017, it acquired AppDynamics, a software platform used by IT organizations to monitor corporate systems and infrastructure. AppDynamics experienced double-digit year-over-year growth in the third quarter, continuing its double-digit growth from the previous quarter.
Cisco's IT security solutions saw 6% year-over-year growth in the third quarter, following 9% growth in the previous quarter, proving its resilience to the economic downturn of the coronavirus pandemic.
The software applications and security segments have steadily increased as a portion of its products revenue. This quarter, they accounted for 25%, up from 19% in 2017.
Cisco uses a software-as-a-service (SaaS) subscription model for many of its software products. The SaaS model enables it to earn recurring revenue, and the company has successfully driven up its SaaS sales. They represent 74% of its third-quarter software sales, compared to 65% a year ago, and 72% in the previous quarter.
SaaS sales help, but a greater opportunity lies in the advancement of 5G technology and the Internet of Things (IoT). Both technologies rely on networking hardware to deliver wireless access to the growing list of devices connecting online, from watches to automobiles, enabling the company to drive sales of its core networking products. The IoT alone is predicted to become a $1.1 trillion market by 2026. In the third quarter, Cisco saw double-digit growth in IoT software.
Cisco also manages its financial health well. It ended the third quarter with $10.4 billion in cash and equivalents, and operating cash flow of $4.2 billion, while paying out $2.5 billion to shareholders in the form of dividends and share repurchases. The company stated that it intends to return at least half of its free cash flow to shareholders annually.
The final verdict
In the short term, Cisco will continue to experience revenue declines. Its fourth-quarter guidance estimates a year-over-year revenue drop in the range of 8.5% to 11.5% as the effects of the pandemic play out.
In the long run, Cisco's strengths and opportunities outweigh its challenges. It continues to make steady progress growing its recurring software revenue, and the emerging technologies of 5G and the IoT will boost the company's hardware segment as these technologies expand over the next few years.
This is not a big growth stock, but it's a well-run company that manages its finances well, rewards patient investors with a dividend currently yielding 3.25%, and can continue to offer a measure of stability even during turbulent times. Cisco is a solid company, and its stock is a buy for the investor with an eye toward the long term.
