Thematic evaluation
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Cisco Systems, Inc. (CSCO)

September 06, 2024

Compared to: Arista Networks, Inc. (ANET) | Motorola Solutions, Inc. (MSI) | Technology Select Sector SPDR Fund (XLK)

Our reasoning

Cisco's current valuation appears moderately undervalued considering its strong market position, improving profitability metrics, and growth potential in AI and cloud infrastructure. The company's P/E and EV/EBITDA ratios are below industry averages, suggesting the market may be underestimating Cisco's ability to navigate challenges and capitalize on emerging opportunities. However, risks such as intense competition and potential integration challenges with Splunk temper the undervaluation assessment.

Key takeaways
  • Cisco is navigating a challenging macroeconomic environment, with customer demand softening and supply chain pressures continuing to impact its operations and financial performance.
  • The acquisition of Splunk represents a strategic move to expand Cisco's security and observability capabilities, but also introduces integration risks and increased debt levels.
  • Cisco's profitability has been declining, reflecting the impact of declining revenue and increasing expenses.
  • The company's liquidity position appears to be weakening, as evidenced by the declining cash balance and increasing short-term debt.
  • Cisco's overall capital allocation strategy appears to be shifting towards debt financing and acquisitions, with a continued focus on shareholder returns through dividends.
  • The company's future financial performance will be influenced by its ability to manage debt levels, control expenses, and successfully integrate the Splunk acquisition.
  • Despite the challenges, Cisco remains a financially strong company with a solid track record of profitability and cash flow generation.
Undervalued
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Evaluation summary

  1. Company Overview:

    • Cisco Systems, Inc. (CSCO) is a leading provider of networking, security, collaboration, and observability technologies. The company's business model is based on designing, manufacturing, and selling a wide range of hardware and software products, as well as providing related services. Cisco's products and services are used by a diverse customer base, including enterprises, public sector organizations, service providers, and cloud companies. The company's target market is the global communications and information technology industry, which is characterized by rapid technological advancements, increasing demand for connectivity, and the growing adoption of cloud computing.
    • Cisco's revenue is generated from the sale of its products and services, which are categorized into several segments, including Secure, Agile Networks, Internet for the Future, Collaboration, End-to-End Security, Optimized Application Experiences, and Other Products. The company's revenue is geographically distributed across the Americas, EMEA, and APJC.
    • Cisco's key competitors include other large telecommunications equipment suppliers, such as Huawei, Ericsson, and Nokia, as well as emerging startups and companies offering "white box" networking hardware. The company faces intense competition in the networking market, with pricing pressure and the need to constantly innovate to maintain its market share.
    • For comparative analysis, we will be using the Technology Select Sector SPDR Fund (XLK) as a benchmark for the broader technology sector, and Motorola Solutions, Inc. (MSI) and Arista Networks, Inc. (ANET) as industry peers.

  2. Financial Performance:

    • Cisco's revenue has been declining in recent quarters, indicating a challenging macroeconomic environment and potential competitive pressures. However, the company's revenue growth is still significantly greater than the Industry Average. The acquisition of Splunk is expected to contribute to revenue growth and profitability in the long term.
    • Cisco's profitability has been declining, reflecting the impact of declining revenue and increasing expenses. However, the company's profitability is still significantly greater than the Industry Average, suggesting that Cisco is more profitable than its peers. The restructuring plan announced in Q3 FY2024 is expected to result in cost savings and a realignment of resources, which could improve profitability in the future.
    • Cisco's return on assets (ROA), return on equity (ROE), and return on invested capital (ROIC) have been declining in recent quarters, reflecting the impact of declining profitability and increasing asset base. However, these metrics are still significantly greater than the Industry Average, suggesting that Cisco is more efficient at generating returns on its assets than its peers.
    • Compared to its peers, Cisco has underperformed in terms of revenue growth and profitability. However, the company has a lower risk profile, as evidenced by its lower volatility and beta.

  3. Operational Efficiency:

    • Cisco's asset utilization efficiency is improving, as indicated by the increasing intangible assets and deferred tax assets. The company's free cash flow margin has been increasing, indicating improved efficiency in generating cash flow from operations.
    • Cisco's working capital management has been inconsistent, with significant fluctuations in working capital balances. The company's current ratio and quick ratio are significantly less than the Industry Average, suggesting that Cisco has a lower ability to meet its short-term obligations than its peers.
    • Cisco's cash flow generation is strong, supporting dividend growth and potential for future acquisitions. The Splunk acquisition has significantly impacted investing activities, with a large increase in net assets from acquisitions. The company's capital expenditure efficiency appears to be improving, with investments in new products and infrastructure contributing to revenue growth.
    • Cisco's dividend and share repurchase sustainability is strong, with a consistent track record of returning capital to shareholders. The company's dividend payout ratio is sustainable, and its share repurchase program is supported by strong cash flow generation.
    • Compared to its peers, Cisco has a lower level of financial leverage, as evidenced by its lower debt-to-equity and leverage ratios. However, the company's liquidity position appears to be weakening, as evidenced by the declining cash balance and increasing short-term debt.

  4. Growth Opportunities:

    • Cisco is pursuing growth opportunities in several key areas, including cloud computing, cybersecurity, and artificial intelligence (AI). The company is investing in R&D to develop new products and services that address these emerging trends.
    • Cisco's acquisition of Splunk is a strategic move to expand its security and observability capabilities. The company is also pursuing other M&A opportunities to enhance its portfolio and expand into new markets.
    • Cisco is expanding its geographic reach, particularly in emerging markets, where there is significant growth potential for networking and IT services. The company is also investing in partnerships and alliances to expand its distribution channels and reach new customers.
    • Cisco's management team has a strong track record of executing strategic plans and driving growth. The company has a clear vision for the future and is well-positioned to capitalize on emerging trends in the technology industry.

  5. Risks and Threats:

    • Cisco faces several risks and threats, including the challenging macroeconomic environment, intense competition, cybersecurity and data privacy risks, and regulatory and legal risks.
    • The challenging macroeconomic environment, including inflation, global supply chain challenges, and geopolitical tensions, has impacted IT spending and customer demand. This has led to a decline in Cisco's revenue and profitability.
    • Intense competition from a variety of vendors, including potential disruption from "white box" networking hardware, poses an ongoing threat to Cisco's market share and pricing power.
    • Cybersecurity and data privacy risks are a growing concern, with the company facing potential liabilities from product vulnerabilities and incidents.
    • Regulatory and legal risks, including patent disputes and tax investigations, present additional uncertainties that could impact Cisco's operations and financial results.

  6. Valuation Analysis:

    • Cisco's valuation metrics, such as its price-to-earnings (P/E) ratio and enterprise value (EV) to EBITDA ratio, are currently below the Industry Average. This suggests that the company is undervalued relative to its peers.
    • Compared to its peers, Cisco is trading at a discount, suggesting that investors may be concerned about the company's growth prospects and profitability. However, the company's strong cash flow generation and dividend payments provide some support for its valuation.
    • Potential catalysts for Cisco's stock price include the successful integration of Splunk, the acceleration of growth in key areas such as cloud computing and cybersecurity, and the improvement of the macroeconomic environment.

  7. Price Performance:

    • Cisco's stock price has underperformed the broader technology sector (XLK) over the past few years. However, the company's stock price has shown some recent signs of strength, with outperformance in the 1-week, 1-month, and 3-month periods.
    • Compared to its peers, Cisco's stock price has significantly underperformed. However, the company's lower volatility and beta suggest that it may be a lower-risk investment than its peers.
    • Cisco's stock price is likely to be influenced by the company's financial performance, growth prospects, and the overall macroeconomic environment.

  8. Future Outlook:

    • Cisco's management team is optimistic about the company's future prospects, citing the strength of its portfolio, the integration of Splunk, and the growing demand for AI infrastructure.
    • Analyst estimates for Cisco's revenue and earnings growth are generally positive, but there is some uncertainty about the company's ability to maintain its profitability margins.
    • Cisco's future financial performance will be influenced by its ability to manage debt levels, control expenses, and successfully integrate the Splunk acquisition. The company's ability to capitalize on emerging trends in the technology industry, such as cloud computing, cybersecurity, and AI, will also be critical to its future success.

  9. Summary:

    • Cisco Systems, Inc. (CSCO) is a financially strong company with a solid track record of profitability and cash flow generation. However, the company is facing challenges from a challenging macroeconomic environment, intense competition, and cybersecurity and data privacy risks.
    • Cisco's valuation metrics suggest that the company is undervalued relative to its peers. However, the company's growth prospects and profitability are uncertain.
    • Cisco's stock price has underperformed the broader technology sector and its peers over the past few years. However, the company's lower volatility and beta suggest that it may be a lower-risk investment.
    • Cisco's future financial performance will be influenced by its ability to manage debt levels, control expenses, and successfully integrate the Splunk acquisition. The company's ability to capitalize on emerging trends in the technology industry, such as cloud computing, cybersecurity, and AI, will also be critical to its future success.
Peer fundamentals 
Fundamentals
Insights
  • Cisco is navigating a challenging macroeconomic environment, with customer demand softening and supply chain pressures continuing to impact its operations and financial performance.
  • The acquisition of Splunk represents a strategic move to expand Cisco's security and observability capabilities, but also introduces integration risks and increased debt levels.
  • Cisco's profitability has been declining, reflecting the impact of declining revenue and increasing expenses.
  • The company's liquidity position appears to be weakening, as evidenced by the declining cash balance and increasing short-term debt.
  • Cisco's overall capital allocation strategy appears to be shifting towards debt financing and acquisitions, with a continued focus on shareholder returns through dividends.
  • The company's future financial performance will be influenced by its ability to manage debt levels, control expenses, and successfully integrate the Splunk acquisition.
  • Despite the challenges, Cisco remains a financially strong company with a solid track record of profitability and cash flow generation.
Analysis

  • Revenue - Cisco's revenue has been declining, indicating a challenging macroeconomic environment and potential competitive pressures. - The company's revenue growth has slowed, but it is still significantly greater than the Industry Average. - The acquisition of Splunk is expected to contribute to revenue growth and profitability in the long term.

    • Profitability

      • Cisco's profitability has been declining, reflecting the impact of declining revenue and increasing expenses.
      • The company's profitability is still significantly greater than the Industry Average, suggesting that Cisco is more profitable than its peers.
      • The restructuring plan announced in Q3 FY2024 is expected to result in cost savings and a realignment of resources, which could improve profitability in the future.

    • Liquidity

      • Cisco's liquidity position appears to be weakening, as evidenced by the declining cash balance and increasing short-term debt.
      • The company's current ratio and quick ratio are significantly less than the Industry Average, suggesting that Cisco has a lower ability to meet its short-term obligations than its peers.

    • Solvency

      • The company's long-term solvency appears to be stable, with a healthy level of shareholders' equity.
      • The increasing debt levels should be monitored closely, as they could increase financial risk.
      • Cisco's debt to total equity ratio and debt to EBITDA ratio are significantly less than the Industry Average, suggesting that Cisco has a lower level of financial leverage than its peers.

    • Operational Efficiency

      • Cisco's asset utilization efficiency is improving, as indicated by the increasing intangible assets and deferred tax assets.
      • The company's free cash flow margin has been increasing, indicating improved efficiency in generating cash flow from operations.
      • Cisco's cash flow to total debt ratio has been declining, indicating a decrease in its ability to cover debt obligations with cash flow.

    • Cash Flow Analysis

      • Cisco's cash flow generation is strong, supporting dividend growth and potential for future acquisitions.
      • The Splunk acquisition has significantly impacted investing activities, with a large increase in net assets from acquisitions.
      • The company's capital expenditure efficiency appears to be improving, with investments in new products and infrastructure contributing to revenue growth.

    • Risk Factors

      • The challenging macroeconomic environment, including inflation, global supply chain challenges, and geopolitical tensions, has impacted IT spending and customer demand.
      • Intense competition from a variety of vendors, including potential disruption from "white box" networking hardware, poses an ongoing threat to Cisco's market share and pricing power.
      • The acquisition of Splunk introduces integration risks and increased debt levels.
      • Cybersecurity and data privacy risks are a growing concern, with the company facing potential liabilities from product vulnerabilities and incidents.
      • Regulatory and legal risks, including patent disputes and tax investigations, present additional uncertainties that could impact Cisco's operations and financial results.

    • Future Outlook

      • Cisco's future revenue growth is expected to be influenced by the macroeconomic environment, competitive landscape, and the success of its strategic initiatives.
      • The company's profitability margins are expected to be impacted by its ability to control expenses and leverage the Splunk acquisition.
      • Cisco's balance sheet is likely to continue to be impacted by the Splunk acquisition, with potential for further debt issuance and asset growth.
      • The company's financial flexibility will be influenced by its ability to generate cash flow and manage debt levels.
      • Cisco's future cash flows are likely to be influenced by the Splunk acquisition, with potential for increased debt service obligations and a need to generate sufficient cash flow to support debt repayment and future investments.
Most recent earnings report
Financial statements 
All public filings
Comparative Analysis
Benchmarks (as of 2024-08-20)
Technology Select Sector SPDR Fund (XLK)
  • Performance Comparison:
    • CSCO has consistently underperformed XLK over the past few years, with particularly significant underperformance in the 1-year, 2-year, and 3-year periods. This suggests that CSCO has struggled to keep pace with the broader technology sector. However, CSCO has shown some recent signs of strength, with outperformance in the 1-week, 1-month, and 3-month periods.
  • Risk and Return Analysis:
    • CSCO has provided lower annualized returns than XLK over the past few years. This suggests that CSCO has not been as profitable as the broader technology sector.
    • CSCO has been more volatile than XLK, as evidenced by its higher annualized volatility. This suggests that CSCO's price movements have been more unpredictable than the broader technology sector.
    • CSCO has experienced larger maximum drawdowns than XLK, indicating a higher risk profile. This suggests that investors in CSCO may be exposed to greater potential losses during market downturns.
  • Risk-Adjusted Performance:
    • XLK has consistently offered a better risk-adjusted return than CSCO, as indicated by its higher Sharpe ratio. This suggests that XLK has been more efficient at generating returns relative to its risk.
    • CSCO's beta values have generally been lower than XLK's, suggesting that CSCO has been less sensitive to market movements than the broader technology sector. This indicates that CSCO may be considered a lower-risk investment than XLK.
  • Overall Assessment:
    • CSCO has consistently underperformed XLK in terms of both absolute and risk-adjusted returns. This suggests that CSCO has not been as profitable or efficient at generating returns as the broader technology sector. However, CSCO's lower beta suggests that it may be a lower-risk investment than XLK.
    • Investors should carefully consider the trade-off between risk and return when evaluating CSCO. While CSCO may offer a lower risk profile, it has not been able to generate returns that match or exceed the broader technology sector.
    • It is important to monitor CSCO's performance and risk profile closely, as well as the broader technology sector, to make informed investment decisions.
Peers Price History(as of 2024-09-04)
Arista Networks, Inc. (ANET)Motorola Solutions, Inc. (MSI)
  • Performance Comparison: Cisco Systems, Inc. (CSCO) has significantly underperformed its peer companies, Motorola Solutions, Inc. (MSI) and Arista Networks, Inc. (ANET), over all historical periods. This underperformance is particularly pronounced over longer timeframes, such as the 3-year period, where CSCO has underperformed MSI by -93.01% and ANET by -270.25%. While CSCO has shown some periods of outperformance in shorter timeframes, such as the 1-month period, its overall performance has been consistently weaker than its peers.
  • Risk and Return Analysis: Cisco Systems, Inc. (CSCO) has provided lower annualized returns compared to its peers, particularly over the 1-year, 2-year, and 3-year periods. However, CSCO has also exhibited lower annualized volatility compared to its peers, suggesting a lower risk profile. This is further supported by the drawdown figures, where CSCO has experienced a larger maximum drawdown compared to its peers, indicating a higher level of risk.
  • Risk-Adjusted Performance: Motorola Solutions, Inc. (MSI) has consistently offered a better risk-adjusted return, as evidenced by its higher Sharpe ratio compared to CSCO and ANET. This suggests that MSI has been able to generate higher returns for a given level of risk. The beta values also indicate that CSCO and MSI have a lower risk profile compared to ANET, as they are less sensitive to market movements.
  • Overall Assessment: Cisco Systems, Inc. (CSCO) has underperformed its peers, Motorola Solutions, Inc. (MSI) and Arista Networks, Inc. (ANET), in terms of both absolute and risk-adjusted returns. While CSCO has a lower risk profile, as indicated by its lower volatility and beta, its lower returns have resulted in a less favorable risk-adjusted performance. Investors seeking higher returns may consider MSI or ANET, while those prioritizing lower risk may consider CSCO. However, it is important to note that ANET has consistently exhibited higher volatility and a higher beta, indicating a higher level of risk.
Peers Fundamentals(as of 2024-07-31)
Arista Networks, Inc. (ANET)Motorola Solutions, Inc. (MSI)
  1. Market Position and Size:
    • CSCO is the largest company in the peer group, with a market cap significantly exceeding its competitors, MSI and ANET. This suggests that CSCO holds a dominant position in the industry, likely due to its established brand, extensive product portfolio, and global reach.
    • CSCO's market cap is strongly correlated with its revenue, EBITDA, and net income. It generates significantly more revenue, EBITDA, and net income than its peers, reflecting its larger scale and market share.
  2. Profitability and Efficiency:
    • CSCO exhibits significantly higher profitability than its peers and the industry average. Its Gross Profit Margin, EBITDA Margin, and Net Profit Margin are all significantly higher than the industry average, suggesting superior operational efficiency and cost control.
    • CSCO's efficiency in generating returns is impressive considering its size and market position. Despite its large scale, it manages to achieve high returns on its assets, equity, and capital. This suggests that CSCO effectively utilizes its resources to generate profits and create value for shareholders.
  3. Financial Health and Stability:
    • CSCO's liquidity position is relatively strong, with a Current Ratio and Quick Ratio that are lower than the industry average but higher than its peers. This suggests that CSCO has sufficient short-term assets to cover its current liabilities.
    • CSCO's debt position is relatively conservative, with a Total Debt to Total Equity Ratio and Debt / EBITDA that are lower than the industry average but higher than its peers. This indicates that CSCO has a lower level of debt compared to its peers and the industry, suggesting a more stable financial structure.
  4. Valuation and Market Perception:
    • CSCO's valuation is relatively attractive compared to the industry average, but less so compared to its peers. Its lower Enterprise Value To Sales, Enterprise Value To EBITDA, Price To Earnings, Price to Book Ratio, and Price To Sales Ratio suggest that the market may be undervaluing CSCO relative to the industry, but its peers may be more highly valued.
    • CSCO's valuation is lower than its peers, suggesting that the market may be less optimistic about its future growth prospects compared to its competitors. However, its valuation is still higher than the industry average, indicating that investors still perceive CSCO as a relatively attractive investment.
  5. Cash Flow and Capital Management:
    • CSCO generates significantly more Net Operating Cash Flow, Total Capital Expenditure, and Free Cash Flow than its peers, considering their market caps. This demonstrates its ability to generate significant cash from operations and invest in its growth.
    • CSCO's cash flow generation strength is significantly higher than its peers, reflecting its larger scale and more mature business model. This suggests that CSCO has a strong foundation for future growth and value creation.
  6. Growth and Future Prospects:
    • CSCO's growth trends show a mixed picture compared to the peer group average. While CSCO has consistently underperformed in revenue, EBITDA, net income, basic earnings per share, free cash flow, and free cash flow margin growth, it has outperformed in total asset growth.
    • CSCO's growth rates have been consistently decreasing over the 5-year period for most metrics, indicating a deceleration in growth. Its most recent year-over-year growth rates are generally lower than its 5-year CAGRs, further confirming this trend.
    • CSCO's growth is concentrated in total assets, while other key metrics like revenue and profitability have shown deceleration. This suggests that CSCO may be investing heavily in its business but not yet seeing a corresponding increase in revenue or profits.
  7. Potential for Investment:
    • CSCO is a large, profitable company with a strong financial foundation. Its high profitability, efficient cash flow generation, and conservative debt position make it a relatively attractive investment. However, its declining growth rates and lower returns on capital compared to its peers suggest that it may be facing challenges in maintaining its competitive advantage in a rapidly evolving technology landscape.
    • Investors should carefully consider these factors before making an investment decision.
  8. Key Risks and Considerations:
    • CSCO's declining growth rates and lower returns on capital compared to its peers suggest that it may be facing challenges in maintaining its competitive advantage in a rapidly evolving technology landscape.
    • Investors should carefully consider these factors before making an investment decision.
  9. Overall Assessment:
    • CSCO's overall financial health is strong, characterized by high profitability, efficient cash flow generation, and a conservative debt position. However, its growth rates have been decelerating, and its returns on capital are lower than its peers.
    • CSCO's financial performance is impressive considering its size and market position. Its strong profitability and cash flow generation demonstrate its ability to generate value for shareholders. However, its declining growth rates and lower returns on capital compared to its peers suggest that it may be facing challenges in maintaining its competitive advantage in a rapidly evolving technology landscape.