Shares of Cisco Systems (CSCO 0.61%) treaded water on Thursday after the networking-hardware provider reported blockbuster results for the fiscal third quarter, which ended April 29. Revenue soared, driven by the core switching and routing business, and the company boosted its guidance for the full year.
Investors, though, were looking to the future. Cisco reported a steep decline in product orders, the precursor to generating product revenue, across all geographies and customer types. The worry is that tumbling product orders will give way to slumping revenue down the line.
Should investors avoid Cisco stock due to this product-order weakness? Or is this a prime opportunity to pick up shares of this dominant tech company?
Almost everything is going right
Cisco reported Q3 revenue of $14.6 billion, up 14% year over year. That result was ahead of the company's guidance range, which called for growth between 11% and 13%. It was Cisco's core business that did almost all the heavy lifting. Sales in the secure, agile networks segment, by far the largest, soared 29% year over year to $7.55 billion.
Spread across Cisco's segments is a growing amount of software revenue. Cisco reported $4.3 billion in software revenue in Q3, up 18% year over year. Subscription-software revenue reached $3.5 billion, up 17% year over year. There's an elevated number of software orders in Cisco's backlog, partly because some of that software is tied to hardware that has yet to be delivered.
Cisco's profits jumped along with revenue. The company reported generally accepted accounting principles (GAAP) earnings per share of $0.78 and non-GAAP earnings per share of $1.00, up 7% and 15%, respectively. In the nine months ended April 29, Cisco produced free cash flow of $13.3 billion, up from $9.2 billion in the prior-year period.
The company sees this momentum continuing into Q4. Cisco guided for Q4 revenue growth between 14% and 16%, and it boosted its full-year revenue-growth guidance to a range of 10% to 10.5%.
What to make of plunging product orders
While Cisco's revenue and earnings are soaring, there's something to be concerned about under the surface. Total product orders plunged 23% year over year in Q3. No geographic area was spared. Orders in the Americas fell 24%; orders in Europe and surrounding regions slumped 19%; and orders in the Asia-Pacific region tumbled 28%.
Every type of customer is pulling back to varying degrees. Enterprise orders dropped 22%; public sector orders fell 11%; commercial orders dipped 19%; and service provider orders crashed 47%.
The good news is that the rate that Cisco is taking product orders is not the only factor that drives future revenue growth. During much of the pandemic, a volatile supply chain led to shortages and delays shipping products. Customers were forced to put in orders earlier than usual and order more than usual.
The supply chain situation is now improving. Cisco is shipping products at a faster rate, and its biggest customers are waiting to absorb those shipments before placing new orders. Lead times have improved as well, so customers no longer feel the need to order so far in advance. This normalization is driving a big chunk of the decline in product orders.
The state of the global economy is also contributing to the decline in product orders. Cisco's customers tend to pull back when economic uncertainty creeps in, and that can eventually lead to a decline in revenue. The good news is that Cisco's product backlog is expected to be roughly twice the size as normal at the end of the fiscal year, so any economy-driven order declines won't show up as revenue declines for now. Cisco's cancellation rates remain below historical levels, a sign that customers aren't pulling back all that hard just yet.
Time to buy Cisco stock?
The decline in product orders shouldn't be ignored, and Cisco's results will eventually suffer if the economic picture worsens. But a strong backlog and low cancellation rates should give investors confidence that Cisco's business will hold up reasonably well over the next few quarters.
Cisco expects to produce non-GAAP earnings per share between $3.80 and $3.82 in the current fiscal year, which puts the price-to-earnings (P/E) ratio at about 12.5. While earnings could decline if customers hit the brakes harder, Cisco stock certainly doesn't look expensive. For long-term investors able to stomach some volatility, Cisco looks like a solid buy.
