Cisco Systems Rebound is On: Double-Digit Upside to Come

Key Points

• Cisco Systems struggled in Q3, but signs of normalization and a return to growth are present. 
• Analysts like what they see and are helping to support the market. 
• Capital returns are safe, reliable, and expected to grow. 

Cisco Systems' NASDAQ: CSCO headwinds are diminishing, opening the door to a rebound and sustainable rally that could lift the share price by double-digits. While end-market inventory normalization is still underway in the networking segment, other segments are growing, and the integration of Splunk is progressing well. The takeaway is that an inflection point is at hand that will lead the company back to growth, and that should lead to increased share prices. The only question is if the market can rally over the summer or if it will wait until later in the year. 

Cisco Systems Q3 is Better Than Feared: Guidance Favorable

Cisco Systems Q3 revenue contracted 12.8% to $12.7 billion but came in better than expected. The take is $0.07 billion ahead of the consensus reported by Marketbeat.com due to the successful transition to subscription-based services. Subscriptions are up to 54% of the net, with total annual recurring revenue up 22% and product ARR up 44%. 

Total product sales are down due to weakness in the networking segment, but other segments, including Security and Observability, are up by double-digits. High-end-market inventory levels impact the networking segment, but analysts expect normalization to be completed by July. 

Profitability was another area of strength. The company’s GAAP and adjusted gross margin came in strong at 65.1% and 68.3% despite the decline in revenue. The net result is $0.88 in adjusted earnings, down only 12% compared to the 12.8% top-line decline and $0.06 ahead of the analysts' consensus. 

The guidance is favorable and supported by a 21% increase in RPO. Guidance expects the Q4 revenue to be up sequentially and as expected relative to analysts' estimates, with strength on the bottom line. The takeaway is that, including the Q3 strengths, the full-year guidance is above consensus at the top and bottom lines, leading the analysts to raise their estimates and price targets. The post-release action is mixed; not all analysts are raising their targets, but the net result is an increase in the consensus estimate of 12.5% above the current action. 

Cisco Systems Capital Returns are Safe and Reliable

Cisco Systems' cash flow and balance sheet reflect the YOY contraction and recent acquisitions but remain strong, healthy, and positioned to continue with capital returns. Highlights from the report include $4 billion in cash flow, down compared to last year, and a reduction in cash and inventory compounded by increased debt, but total assets and equity are up. Long-term debt is less than 0.5X equity, so no red flags are present.

With these metrics, Cisco’s dividends and share repurchases should continue at their current pace and may increase over time. Share repurchases reduced the count by an average of 1.2% in Q1, so they are accretive to investors. The dividend has a high yield of 3.25% and is cheap for a blue-chip tech stock, valued at only 13X earnings. The company has a track record of distribution increases, so investors may expect another low-single-digit increase this year. 

Insiders Sell Cisco: Institutions Buy It

Insiders have been selling shares of CSCO, but there is nothing to worry about. The insiders own a slim 0.2% of the stock, and their activity aligns with share-based compensation and related sales. More importantly, the institutions own more than 70% of the stock and have been buying on balance in 2024. Their activity aligns with the market bottom, which formed over the past six months and provides a tailwind for the market. 

The technical action following the report is mixed. The market surged by 1% at the open and was on track to continue higher, but profit-taking and a sell-the-news mentality capped gains. The market quickly reversed to fall more than 1.5%, creating a solid red candle that may cap gains over the summer. In this scenario, the market could move sideways in consolidation until later in the year when more evidence of the turnaround and return to growth is available.