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6 Bright Spots in Cisco's Disappointing Q4 Report

By Leo Sun – Aug 16, 2020 at 11:00AM

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The networking giant's growth hits a brick wall -- but investors shouldn't ignore these pockets of strength.

Cisco's (CSCO -3.01%) stock recently tumbled after the company followed up its fourth-quarter earnings beat with downbeat guidance for the first quarter.

The networking hardware and software giant's revenue fell 9% annually to $12.2 billion, clearing estimates by $60 million but marking its third straight quarter of declining revenue. Adjusted earnings per share dipped 4% to $0.80, but still beat expectations by $0.06.

Those growth rates were weak, but it was likely Cisco's guidance that sparked the sell-off. It expects its first-quarter revenue to decline 9%-11% annually, missing expectations for a 7% decline, and for its adjusted EPS to fall 15%-18%, well below the consensus forecast for a 10% drop.

Networking connections across the globe.

Image source: Getty Images.

That bleak outlook indicates Cisco's troubles -- which include COVID-19 disruptions, sluggish orders from enterprise and data center customers, and competition from rivals like Arista Networks (ANET -4.50%) and Juniper Networks (JNPR -2.90%) -- won't end anytime soon. But before giving up on Cisco, investors should examine six bright spots in its otherwise disappointing report.

1. The growth of its security business

Cisco's infrastructure platforms and application revenues declined, but its security revenue (7% of its top line) grew 10% annually.

Over the past eight years, Cisco acquired a dozen cybersecurity companies -- including Sourcefire, ThreatGRID, and Duo Security -- to expand that business. Cisco bundles these security products with its hardware and applications to lock in customers.

During the conference call, CFO Kelly Kramer attributed the security unit's growth to the "strong performance" of its network security, identity and access, advanced threat, and unified threat management solutions. Its cloud security revenue also grew by double digits.

2. The growth of Webex and AppDynamics

Cisco's applications revenue (11% of its top line) declined 9% annually, due to lower demand for its Unified Communications platform and TP (telepresence) endpoint solutions.

A woman talking and gesturing in front of her laptop.

Image source: Getty Images.

But within that business, revenue from its Webex video collaboration platform -- which competes against Zoom (ZM -2.25%) and other similar services -- grew by the double digits as more people worked remotely. Kramer also said AppDynamics, which runs diagnostics and analyzes data for big IT departments, generated "solid growth."

Cisco doesn't disclose either platform's exact revenue yet, but their strength throughout the crisis is encouraging.

3. The software and services segment's revenue share

Cisco generated 51% of its revenue from software and services in fiscal 2020, which exceeded its own target of 50%. Subscriptions also accounted for 78% of its software revenue, easily surpassing its 66% target.

That higher mix of software and subscriptions locks customers into Cisco's ecosystem and widens its moat against its competitors. It also generates more consistent revenues at higher margins than its hardware business.

4. Stable gross margins

Cisco's adjusted gross margin dipped 50 basis points annually to 65% in the fourth quarter, but it expects that figure to remain stable at 64%-65% in the first quarter.

By comparison, Arista's adjusted gross margin stayed flat annually at 64.7% last quarter, while Juniper's adjusted gross margin declined 90 basis points to 58.3%.

Cisco's market-leading margins suggest its scale still gives it plenty of pricing power in the networking market. According to IDC, Cisco controlled 51.9% of the global Ethernet switch market in the first quarter of 2020, as well as 36.3% of the combined service provider and enterprise router market -- making it the leader of both markets by a wide margin.

5. Rising deferred revenues

Cisco's deferred revenue, a key indicator of future demand, rose 11% annually to $20.4 billion. Within that total, its deferred product revenue grew 17% and its deferred service revenue rose 7%. Those advance payments indicate Cisco's business isn't headed off a cliff, even as its near-term revenue and profits decline.

6. Programs rewarding patient investors

Many tech companies halted their buybacks or suspended their dividends to conserve cash throughout the COVID-19 crisis. But in fiscal 2020, which ended on July 25, Cisco spent 59% of its free cash flow on $6 billion in dividends and $2.6 billion in buybacks.

It doesn't plan to interrupt either program, and it ended the quarter with $29.4 billion in cash, cash equivalents, and investments -- which gives it plenty of room to raise its buybacks and dividends while acquiring more companies.

Moreover, Cisco's forward yield of 3% and its low forward P/E ratio of 16 could set a floor under its stock until its core business recovers.

The key takeaways

Cisco's outlook for the first quarter was alarming, but it's survived plenty of downturns before. These six bright spots indicate Cisco isn't doomed, but its stock probably won't rebound until the macro headwinds wane and the company generates sustainable revenue growth again.

Leo Sun owns shares of Cisco Systems. The Motley Fool owns shares of and recommends Arista Networks and Zoom Video Communications and recommends the following options: short August 2020 $130 calls on Zoom Video Communications. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Cisco Systems, Inc. Stock Quote
Cisco Systems, Inc.
$40.27 (-3.01%) $-1.25
Juniper Networks Stock Quote
Juniper Networks
$26.74 (-2.90%) $0.80
Arista Networks Stock Quote
Arista Networks
$116.41 (-4.50%) $-5.49
Zoom Video Communications Stock Quote
Zoom Video Communications
$76.59 (-2.25%) $-1.76

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