19 March 2011

CSCO: Financial Gauge Analysis for the January 2011 Quarter

We have updated the various financial metrics we use to analyze Cisco Systems' (NASDAQ: CSCO) Cash Management, Growth, Profitability and Value.  This post reports on the metrics and the associated financial gauge scores. 

The metrics were calculated using data from Cisco's current and historical financial statements, including those in the latest 10-Q.

A previous article examined in some detail Cisco's Income Statement for the January-ending second quarter of fiscal 2011.  The company earned $0.27 per diluted share on a GAAP basis, down 14 percent from $0.32 in the same three months of the previous year. 

Before getting into the details, we will take a step back to introduce the subject of today's analysis.

Cisco Systems, Inc., the proud plumber of the Internet, has a dominant role in markets for enterprise networking products and services. 

Cisco's earnings rose 27 percent in fiscal 2010, which ended in July, from $6.13 billion to $7.77 billion.  Revenue increased 11 percent, from $36.1 billion to $40.0 billion.  Fiscal 2010 included a 53rd week.

The market value of the company has fallen from approximately $120 billion to under $100 million, on a fully diluted basis, in the last couple of months.

In 2011, Cisco initiated its first cash dividend, $0.06 per share per quarter, to shareholders. 

Cisco categorizes its products as Routers, Switches, Advanced technologies, and other.  Switches generated the most Revenue in fiscal 2010, $13.6 billion, which was 42 percent of net product sales. 

Revenue from product sales was supplemented by $7.6 billion in Revenue from services in fiscal 2010.  Service revenue was 19 percent of total Revenue in fiscal 2010.

The company's business segments for financial data reporting are defined by geographic region or "theaters": United States and Canada, European Markets, Emerging Markets, Asia Pacific, and Japan.  The U.S./Canada segment provided 54.3 percent of fiscal 2010's Total Revenue.

Juniper Systems (NASDAQ: JNPR) is usually considered Cisco's most direct competitor in the enterprise market.

Cisco has long been a serial acquirer, insatiably gobbling up companies of all sizes.  In 2010, Cisco's two largest acquisitions were Tandberg, for $3.3 billion, and Starent Networks, for $2.6 billion.

Cisco's Balance Sheet in January 2011 listed nearly $40 billion in Cash and Short-term Investments, which would seem to be an adequate war chest for further acquisitions.  However, much of this cash is believed to be overseas.

Gartner has predicted $3.5 trillion will be spent on Information Technology in 2011, up 5.1 percent from last year.  However, in a separate announcement, the well-known researcher was less sanguine about spending on Enterprise Information Technology, forecasting a modest 3.1 percent rise in 2011.  Gartner commented that EIT spending growth would be "timid and at times lackluster" during the next five years.

Tepid industry spending would test Cisco's frequent assertion that its revenue can expand over the long term at a rate between 12 and 17 percent per year.

In a major diversification effort, Cisco introduced in 2009 the Unified Computing System for large data centers.  Since the UCS platform includes computer servers, storage systems [from EMC (NYSE: EMC)], and networking gear, the UCS puts Cisco into direct competition with heavyweights Hewlett-Packard (NYSE: HPQ), IBM (NYSE: IBM), and others.  HP responded by challenging Cisco on its home turf when it acquired 3Com.

Cisco has also branched out into home entertainment, tablet computers (the Cius), video camcorders, and smart grid technology.  Cisco might be satisfied if these products merely increases the demand for enterprise network infrastructure. 

Now we turn to the financial gauges.  The latest quarterly results produced the following changes to the scores:

Current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.  Readers are encouraged to verify these figures and calculate others as they see fit using the filings available at the SEC's web site and elsewhere.

Cash Management29 Jan 201130 Oct 201023 Jan 20105-Yr Avg
Current Ratio2.
LTD to Equity26.6%27.3%36.6%23.9%
Debt/CFO (years)
Inventory/CGS (days)31.730.631.936.3
Finished Goods/Inventory62.7%59.1%61.3%61.0%
Days of Sales Outstanding (days)38.536.532.634.1
Working Capital/Revenue77.9%78.1%84.8%59.8%
Cash Conversion Cycle Time (days)51.047.544.848.2
Gauge Score (0 to 25)911913

The Cash Management gauge lost two points, falling below the 10-point threshold, primarily because of changes to the Inventory metrics.

The company's hoard of Cash and Short-term Investments totaled $40.3 billion, a record high amount, on 29 January.  Working Capital -- the difference between Current Assets and Current Liabilities -- is now $33.6 billion, which is also near a record high. Neither acquisitions, nor share repurchases, have diminished this stockpile of liquid funds.

Cisco has commented that tax considerations limit its ability to repatriate the earnings of overseas subsidiaries.

In the first six months of the current fiscal year, Cisco spent $4.3 billion to repurchase 202 million of the company's shares, at an average price of $21.27 per share.  These purchases, which reduce shareholders' equity, have not boosted the market price of the the shares.

More of Cisco's cash will be returned to investors when the company pays its first cash dividend.

Long-term Debt, which got as high as $15.2 billion when Cisco issued $5 billion in new debt last November, is now down to $12.2 billion.  In addition, Cisco has $3.1 billion in obligations due to mature in the next year.  Total debt remained steady at 1.5 years of Cash Flow from Operations.

When measured in days of Cost of Goods Sold, Cisco's Inventory edged up one day in the most recent quarter.  However, the Inventory level is about the same as it was in the year-earlier quarter.

The greater proportion of Finished Goods in the Inventory might be a greater concern.  The rise could be a sign sales were slower than the company expected.

Cash efficiency suffered when judged by increases in Days of Sales Outstanding and the related Cash Conversion Cycle Time.

Growth29 Jan 201130 Oct 201023 Jan 20105-Yr Avg
Revenue Growth19.2%20.0%-10.2%6.3%
Operating Profit Growth-0.7%1.6%1.4%4.1%
CFO Growth31.7%19.4%-36.2%0.2%
Net Income Growth24.9%38.3%-19.0%2.2%
Gauge Score (0 to 25)151709
Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.  The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.
The Growth gauge experienced a minor setback after two quarters of significant increases.

Revenue growth flattened out at 19 percent, nothing to sneeze at, on a trailing-year basis.  More worrisome was that Revenue in the January 2011 quarter was only 6 percent greater than in the quarter that ended in January 2010.

Revenue as a percentage of total assets diminished after previous rises.

The trailing-year growth rates for Cash Flow from Operation and Net Income are robust, although the latter showed signs of moderating.

Operating income, over a longer period, is not yet showing the kind of growth rate one expects from a company with Cisco's ambitions.

Profitability29 Jan 201130 Oct 201023 Jan 20105-Yr Avg
Operating Expense/Revenue78.1%76.3%77.1%75.8%
Free Cash Flow/Invested Capital48.8%51.0%45.7%63.2%
Accrual Ratio1.8%10.5%13.9%10.2%
Gauge Score (0 to 25)17151214

The Profitability Gauge added to its healthy 15-point score.  The gauge benefited from big decline in the Accrual Ratio.

The increase in Operating Expenses per Revenue dollar (i.e., a lower Operating Margin) is a disappointment.

The Return on Invested Capital and Free Cash Flow to Invested Capital ratios both slipped slightly in the last quarter, but they remained more robust than they were one year earlier.

Value29 Jan 201130 Oct 201023 Jan 20105-Yr Avg
P/E vs. S&P 500 P/E
Enterprise Value/Cash Flow (EV/CFO)8.810.213.911.3
Gauge Score (0 to 25)131119
Share Price ($)$20.93$22.86$22.97-

The Value gauge added to its score primarily because of the decline in the share price.  The shares have dropped further since the quarter ended.

The Price/Earnings multiple is no longer sky high.  The PEG ratio is listed as negative because we calculate

The Price-to-Sales Ratio and the EV/CFO ratio are also both relatively low for Cisco, which is a positive factor for the Value gauge.

Cisco's current share price today is near $17.  At this price, the Value gauge would soar to a very appealing 19 of the 25 possible points.  Nine more points would be tacked onto the Overall gauge score.

Overall29 Jan 201130 Oct 201023 Jan 20105-Yr Avg
Gauge Score (0 to 100)54512345

Two of the four category gauges improved during the January quarter, and two weakened. None of the changes were greater than two points. 

Since the Value gauge is double-weighted, it was able to lift the Overall score.  The score is more than double what it was one year ago.

Today's lower stock price would bring the score up to 63, a very good result.  However, the lower price also reflects investor concerns about the potential for weaker growth.

Full disclosure: Long CSCO at time of writing.

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