06 February 2009

CSCO: Financial Analysis through January 2009

This post contained an error involving Cash Flow from Operations that incorrectly reduced the Overall Gauge score by four points.  Please see this Update

Cisco Systems announced earnings for the three months that ended on 24 January, which was the second quarter of the company's fiscal 2009.  This post provides the GCFR analysis of the financial statements.

With sales falling, Cisco Systems closed its North American units for 5 days around New Years Day.

Cisco Systems, Inc. (NASDAQ: CSCO), the proud plumber of the Internet, has a commanding position in the market for enterprise networking products and services, such as routers.  Cisco also sells devices intended for home use.

Management often expresses confidence that Cisco can expand its Revenue over the long term at a rate between 12 and 17 percent.  As recently as 3 December 2008, CEO John Chambers was quoted by Reuters as saying: "We're very comfortable, with the appropriate normal economic conditions, of growing our business in the 12 to 17 percent range."  The company adds caveats acknowledging that Revenue will be above or below this range in some quarters.

Three months ago, the GCFR Overall Gauge of Cisco Systems increased from 61 to 64 of the 100 possible points.  Our initial and updated analysis reports explained the score in some detail.

The rising score in the October quarter was mostly due to strengthening of the contrarian Value gauge.  The Growth gauge was especially weak, as the slowing worldwide economy took its toll on Cisco's falling Revenue, Cash Flow, and Net Income growth rates.

Now, with data available from the January 2009 quarter, our gauges display the following scores:

Before examining the factors that affected each gauge, we will compare the latest quarterly Income Statement to our previously announced expectations.
We use the Income Statement prepared in accordance with U.S. GAAP, rather than the non-GAAP ("pro forma" or "ex-items") data that gets so much attention.  In the latest quarter, the difference between GAAP and non-GAAP results is more than $360 million.
Please note that the tabular format below, which we use for all analyses, can and often does differ in material respects from company-used formats.  A common difference is the classification of income and expenses as Operating and Non-Operating. The standardization is simply for convenience and to facilitate cross-company comparisons.


Revenue in the latest quarter was 7.5 percent less than in the January 2008 quarter.  This was actually a little better than we anticipated because we expected an 8.0 percent Revenue decline.  Of Cisco's various product lines, routers suffered the largest drop in Revenue (-23 percent).
The Cost of Goods Sold (CGS) was 37.0 percent of Revenue, which translates into a Gross Margin of 63.0 percent.  Our estimate had been 63.75 percent.
Research and Development (R&D) expenses were 14.1 percent of Revenue.  We were expecting 13.8 percent, so the R&D expenses were slightly more than we estimated.
Sales, General, and Administrative (SG&A) expenses were 27.9 percent of Revenue, which exceeded our 27.1 percent estimate.
Other operating expenses (primarily amortization of purchased intangible assets) were $10 million more than our prediction.
Operating Income was 26.2 percent less than last year's value, and it was 8.6 percent below our prediction.  Higher CGS and higher SG&A expenses were the main reasons Operating Income growth fell short of our estimate.

Non-operating interest and other income was $35 million less than expected.  The Income Tax Rate was only 19.5 percent, instead of the predicted 22 percent.  The tax rate was 21.9 percent in the January 2008 quarter.
Net Income was 27 percent under last year's value and 6.9 percent short of our prediction.  Earnings per share were down to 26 cents from 33 cents.  (Cisco repurchased 37 million of its shares during the quarter.)
Cash Management January
3 months
12 months
Current Ratio 2.8 2.6 2.7
LTD/Equity 17.3% 18.2% 20.9%
Debt/CFO 0.6 yrs 0.6 yrs 0.6 yrs
Inventory/CGS 30.5 days 32.1 days 39.3 days
Finished Goods/Inventory 64.0% 64.2% 64.7%
Days of Sales Outstanding (DSO) 32.5 days 30.3 days 34.3 days
Working Capital/Market Capitalization  25.8% 19.6% 12.8%
Cash Conversion Cycle Time (CCCT)
45.0 days 41.6 days 50.0 days
Gauge Score (0 to 25)
The Balance Sheet metrics indicate financial strength.  Debt is minimal, and the company has close to $30 billion of cash and short-term investments.  If the economy and credit markets were healthy, we might suggest that the Working Capital level is excessive.  Cisco has done a good job keeping the Inventory levels lean, despite rapidly falling revenue.   While there was a little bounce up in the Cash Conversion Cycle Time, the downward trend indicates that Cisco's legendary cash management efficiency is improving.
Growth January
3 months
12 months
Revenue growth 5.0% 11.1% 18.0%
Revenue/Assets 67.8% 70.4% 74.2%
CFO growth 4.6% 7.3% 12.0%
Net Income growth -7.2% 1.5% 24.7%
Gauge Score (0 to 25) 1
Growth rates are trailing four quarters compared to four previous quarters.

A comparison of the Growth metrics today and 12 months ago tells the sad story of across-the-board weakness.

Profitability January
3 months
12 months
Operating Expenses/Revenue 77.4% 76.3% 75.4%
ROIC 50.1% 49.6% 43.2%
FCF/Equity 28.6% 30.1% 31.7%
Accrual Ratio 10.8% 3.6% 1.8%
Gauge Score (0 to 25) 11

An upward trend in Operating Expenses, which squeezes the Gross Margin, can be discerned.  However, the ROIC and FCF are holding up well.  Alas, the big increase in Accrual Ratio signals that earnings quality has weakened.

Value January
3 months
12 months
P/E 11.7 13.2 18.8 21.9
P/E to S&P 500 average P/E 86% 89% 113% 127%
Price/Revenue 2.2 2.6 4.0 4.9
Enterprise Value/Cash Flow (EV/CFO) 5.8 7.4 12.7 15.0
Gauge Score (0 to 25) 22

Shares of Cisco Systems decreased in price from $17.77 on 31 October 2009 to $14.97 on 31 January 2009.   The valuation metrics are all now at substantial discounts to historical norms.  Of course, the longer-term averages were mostly achieved when Revenue and Net Income were growing briskly, which is not the case today.

Cisco's valuation ratios can be compared with other companies in the Networking & Communication Devices industry.

Overall January
3 months
12 months
Gauge Score (0 to 100) 62

In the January quarter, Revenue fell sharply, and Income failed to meet our diminished expectations.  Even though Growth came to a halt, Cisco still managed to earn $1.5 billion.  The company has the resources and Cash Management clout to weather a very long downturn.

No comments:

Post a Comment