Cisco Systems Inc (NASDAQ: CSCO) stock has underperformed this year, falling by about 2% since early January. In comparison, Palo Alto Networks stock has gained about 13% over the same period. Now Cisco is expected to publish its Q4 FY’24 earnings shortly. We expect revenue to come in at $13.56 billion, down by about 6% compared to last year, while earnings are likely to come in at $0.86 per share, slightly ahead of consensus estimates, but down from $1.08 last year. So what are some of the trends that are likely to drive Cisco’s results for the quarter?
Cisco’s product sales have witnessed a slowdown as customers have been focused on installing and implementing the products purchased over the last few quarters. Moreover, large companies, including cloud service providers and telecommunication players, have held back on network-related capital expenditures on account of economic uncertainty. Separately, Cisco is also facing competition from smaller networking companies and this is also impacting growth. Over Q3 FY’24, Cisco saw its revenue fall by almost 13% year-over-year to $12.7 billion, with adjusted earnings coming in at $0.88 per share. That said, Cisco indicates that demand appears to be stabilizing as customers work through their existing inventory and we could begin to witness some improvement from Q4 onward.
In March, the company closed a deal to buy Splunk, a software player that provides tools to analyze log files, and other data, using artificial intelligence to help companies minimize the risk of cybersecurity incidents. Q4 FY’24 will mark the first full quarter post the close of the deal and we will be looking for updates on the integration. Cisco intends to cross-sell Splunk products to drive revenue synergies, indicating that it has identified about 5,000 existing Cisco customers that could also become Splunk customers.
Cisco has been making progress with gross margins in recent quarters, driven by lower freight and component costs, a favorable product mix, and overall better cost management. Over Q3 FY’24, gross margins rose to 65%, up 170 basis points compared to the year-ago period. We could see similar trends over Q4 as well. The company has been increasingly pushing toward a recurring revenue model with its software subscriptions and service contracts which could also help margins. Over the last quarter, total annualized recurring revenue stood at $29.2 billion including $4.2 billion from its acquisition of Splunk.
CSCO stock has gained about 8% from January 2021 to now, vs. an increase of about 46% for the S&P 500 over this roughly 3-year period. Overall, the performance of CSCO stock with respect to the index has been lackluster. Returns for the stock were 46% in 2021, -22% in 2022, and 9% in 2023. In comparison, Arista Networks, another networking company has seen its stock surge by about 300% over the same period. Arista is a market leader in high-speed networks catering to hyper-scalers and big corporations that are major stakeholders in the generative AI trend. Turns out, Arista is part of the 30-stock Trefis High Quality Portfolio, which has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Now, will Cisco stock fare better going forward?
We believe CSCO stock is somewhat undervalued at current levels. The stock trades at just about 13x consensus earnings for FY’24. We think this is a reasonable valuation, even though growth for this year is likely to be muted. Cisco’s push into the recurring revenue model and its increasing focus on cybersecurity, via acquisitions, could help the stock. We also believe that the company will perform better than its big tech peers in the event of a potential economic downturn given its lower valuation and the secular spending trends on digitization and networking. We value CSCO stock at about $55 per share, which is about 20% ahead of the current market price. See our analysis of Cisco Valuation for a closer look at what’s driving our price estimate for the stock. Also, check out our analysis of Cisco Revenue for more details on the company’s key revenue streams.
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