Cisco Systems' (CSCO +1.15%) stock hit a two-year high after the networking giant posted its fourth-quarter earnings report on Aug. 18. Investors seemed impressed by Cisco's second straight quarter of year-over-year revenue growth (which followed a five-quarter streak of revenue declines) as well as its rosy outlook for fiscal 2022.
Cisco's mature business, low forward P/E ratio of 17, and high forward dividend yield of 2.7% also likely made it more appealing than frothier tech stocks -- many of which tumbled this year amid concerns about their valuations, losses, and tougher post-pandemic comparisons. But is Cisco still worth buying after it rallied more than 30% over the past 12 months? Let's take a closer look at its recovery to decide.
Image source: Getty images.
Why has Cisco struggled over the past two years?
Cisco generated 54% of its sales from its infrastructure platforms business, which sells routers, switches, and other hardware, in fiscal 2021. This core business has faced several challenges over the past two years.
First, Cisco faced fierce competition from rivals like Huawei, Arista Networks, Hewlett Packard Enterprise, and Juniper Networks. Cisco remains the global leader with 49.3% of the ethernet switch market and 37.6% of the combined service-provider and enterprise-router market in the first quarter of 2021, according to IDC. But the commoditization of both markets ultimately limits its growth potential and pricing power.
Meanwhile, the trade war caused Cisco to lose contracts to Huawei and other companies in China. Cisco only generated a small percentage of its revenue in China, but that slowdown coincided with a deceleration in data center and enterprise campus upgrades in other countries. That broad slowdown worsened during the pandemic as companies postponed their network upgrades.
The pandemic also hurt its applications business, which generated 11% of its sales in fiscal 2021, by throttling demand for its unified communications and telepresence products, which are installed in offices to host meetings and conference calls. The segment's video conferencing platform, Webex, also struggled to keep pace with Zoom Video Communications' (ZM +0.42%) simpler platform as more people worked from home.
Cisco's security business, which generated 7% of its revenue last year, continued growing because it was well insulated from the trade war and pandemic. Its services unit, which generated 28% of its sales, also remained stable. However, the strength of those two businesses couldn't offset Cisco's other weaknesses.
Why are investors bullish on Cisco again?
A quick look at Cisco's revenue growth over the past year reveals why its stock is hovering near a two-year high:
|
Revenue Growth YOY (Decline) |
Q4 2020 |
Q1 2021 |
Q2 2021 |
Q3 2021 |
Q4 2021 |
|---|---|---|---|---|---|
|
Infrastructure platforms |
(16%) |
(16%) |
(3%) |
6% |
13% |
|
Applications |
(9%) |
(8%) |
0% |
5% |
(1%) |
|
Security |
10% |
6% |
10% |
13% |
1% |
|
Services |
0% |
2% |
2% |
8% |
3% |
|
Total |
(9%) |
(9%) |
0% |
7% |
8% |
Data source: Cisco. YOY = Year over year.
Not only did Cisco post another quarter of positive revenue increases, its growth also accelerated, with its infrastructure platforms business leading the charge. Cisco attributed that recovery to double-digit order growth across all its end markets and geographies, and noted its product order growth of 31% during the quarter marked its strongest year-over-year rise in a decade.
During the conference call, CEO Chuck Robbins said Cisco experienced its "third consecutive quarter of acceleration in our commercial, service provider, and public sector businesses," and that all three markets grew their orders in excess of 20%. In other words, Cisco is overcoming the cyclical and macro challenges that previously hurt its business.
Cisco's adjusted gross margin also expanded year over year in the fourth quarter as its rising product margin offset its declining service margin:
|
Adjusted Gross Margin |
Q4 2020 |
Q4 2021 |
|---|---|---|
|
Product |
63.2% |
65% |
|
Service |
69.8% |
67.4% |
|
Total |
65% |
65.6% |
Source: Cisco.
CFO Scott Herren said productivity improvements and lower freight costs boosted its product gross margin, and were only "partly offset by relatively modest price erosion." That statement suggests Cisco can still leverage its scale, along with its hardware and software bundling strategies, to maintain its lead in the crowded networking market.
It expects its recovery to continue
Cisco's orders are surging, but it could struggle to meet those orders (and turn them into actual revenue) if it gets hit with component shortages.
Robbins said Cisco faced a component shortage over the past several months, but the company still expects its revenue to rise between 7.5% to 9.5% year over year in the first quarter of 2022, then grow between 5% to 7% for the full year. Both of those estimates surpassed analysts' expectations.
On the bottom line, Cisco expects its adjusted earnings to rise anywhere from 4% to 7% in the first quarter, then grow 5% to 7% for the full year. Both those estimates met Wall Street's expectations.
Cisco's stock is still worth buying
I started accumulating shares of Cisco three years ago, since I liked its low valuation, high dividend, and ability to withstand economic downturns. Those core strengths haven't changed, and they could make it an even more attractive investment this year as macro uncertainties drive more investors toward "mature" tech stocks.
