EUR 850.00 For Business Accounts Only

Morningstar | Strong Quarter by Cisco Showcases High Growth in Nascent Areas; Raising FVE to $49. See Updated Analyst Note from 13 Feb 2019

Narrow-moat Cisco posted 5% year-over-year growth in its second quarter as revenue rose to $12.5 billion. Excluding the divested service provider video business, Cisco grew by 7%, which was in line with our expectations. We are excited to see our long-term thesis, that Cisco's all-encompassing portfolio is attractive and can make it a one-stop shop, is playing out. Cisco in interweaving its high-growth technologies and software focus into a congruent portfolio, and we believe the company can continue its growth streak while gaining operating leverage from selling more software and services. For these reasons, we are increasing our fair value estimate to $49 per share from $46. With shares trading around our fair value estimate, we recommend shareholders hold their position in this security.

Excluding the service provider video business, infrastructure platforms grew by 6%, applications by 24%, security by 18%, and services by 1%, compared with the prior year. The switching and wireless businesses both grew by double digits due to the campus market's uptick of Catalyst 9000 products along with strong Wave 2 and Meraki wireless product sales. The routing business was a headwind due to service providers. Applications exceeded our expectations as AppDynamic's application monitoring and telepresence products garnered strong demand. Security sales boomed as customers are demanding more advanced threat protection, holistic security offerings, and more protection for end users.

Cisco guided 4%-6% sales growth and $0.63-$0.68 EPS for the third quarter. Management projects non-GAAP gross margin to increase slightly at the midpoint, and for non-GAAP operating margin to be consistent with the previous year. We model Cisco slightly exceeding its earnings targets and for revenue to be on the high side of guidance. Cisco announced a 6%, or $0.02 per share, dividend increase for next quarter alongside proclaiming an additional $15 billion authorized for share repurchases.

We are encouraged that Cisco's focus on growing subscriptions and software sales is bearing fruit. Subscriptions, as a percentage of software, grew 10% year over year and we expect subscriptions to continue picking up as customers refresh products and move to Cisco's subscription-based model. We expect an increased amount of recurring revenue to make Cisco less vulnerable to IT spending lulls, and we believe the company is becoming less reliant on hardware refresh cycles. Additionally, we posit that Cisco's broad portfolio is in favor with companies who are attempting to manage workloads in hybrid-clouds and want a consolidated approach. Cisco's ability to cross-sell and upsell software-defined networking solutions, security, and analytics alongside its hardware expertise will keep the company on the shortlist for networking vendors, in our view.

The increased share repurchase amount now brings the total repurchase authorization to $24 billion, with no expiration date. In the second quarter, Cisco paid out $1.5 billion in dividends alongside buying back approximately $5 billion in shares. With its strong cash flow generation, we believe Cisco will continue to aggressively buyback shares, for at least the next two years, to supplement its dividend policy.

From a customer segment perspective, excluding the service provider video business, Cisco had 11% growth within the enterprise sector, 18% growth in the public sector, 7% in commercial, and a 1% decline in service providers as compared with the prior year. The company posted strong growth geographically, with Americas up 7%, EMEA growing by 11%, and APJC up by 6%. In our view, this global growth, across various sectors, is a testament to Cisco's broad, but innovative, portfolio staying ahead of customer needs. We also believe that as networking solutions continue to move toward software-based control, these customer verticals will become less siloed, and that Cisco can leverage its unique vertical experience to produce holistic offerings for multi-cloud ecosystems.

Cisco completed the acquisition of Luxtera for $660 million in February after announcing the deal in the second quarter. Luxtera uses silicon photonics as integrated optical solutions for cloud-based solutions providers, enterprises, service providers. We believe this integration could give Cisco a unique advantage as hardware transitions to 400Gb speeds alongside data proliferation since the company can integrate the specialized chips into its hardware platforms and potentially lower the expensive optical component of networking. In the fiscal second quarter, Cisco completed the divestiture of its service provider video (SPVSS) business. In our opinion, this move helps focus Cisco on solving issues for networking and innovating within software-defined networking, security, and applications.