Update: CSCO: Rising Tides Will Lift Most Boats…Buy Aug Calls In Front of Earnings

by Dan July 28, 2011 9:39 am • Commentary

2nd Update 10:15am:  CSCO getting going here, stock now up over 3%, I sold half my position for a small loss and selling the balance above my avg price, hopefully get out unchanged.

Here is a quick summary from Goldman’s Upgrade note:

We are upgrading Cisco to Buy from Neutral as we believe Street estimates have 
finally bottomed after 4 consecutive guide-downs. Moreover, we believe sales 
growth will bottom in the current quarter, and gross margins will bottom over 
the next 2-3 quarters. Coupled with the announced $1 bn opex cut, we expect 
this will drive almost 300bps of operating margin expansion over the next four 
quarters, fueling 11% EPS growth on 6% sales growth in CY12. In addition, our 
thesis is underpinned by our view that Cisco is not a “broken” franchise, as 
evident in recent customer surveys. With the stock trading at 8.3X our CY12 
EPS estimate and 6.1X ex-cash, and with estimates likely poised for an upward 
revision cycle, we expect Cisco to be a significant outperformer into 2012. We 
see 34% upside to our $21 12-month price target.


Update July 28th, 2011: My thesis hasn’t changed here, but JNPR‘s results Tuesday night clearly signal weakness in some of CSCO’s core businesses.  [private] I am going to use the strength on Goldman Sachs’ upgrade ($16.03) this morning to sell the the Aug 17 calls that I bought on July 7th for .25 now at .22.   Will Update a new longer dated trade as I believe this story may take a little longer to turn itself a round.  Going to take a small loss and look to a more optimal strategy to play CSCO’s turn.

ORIGINAL POST July 7th, 2011:

CSCO ($15.95)  has clearly seen better days, the stock has had 4 consecutive quarters where they have disappointed and lowered the out-quarter guidance.  The company is in the midst of a massive restructuring that was outlined in an open letter from CEO John Chambers to his troops back in early May (read my earlier thoughts here). [private]

-The stock is down 33% in the last year and 21% ytd.

-analyst community is fairly mixed on the name with 20 Buys, 27 holds and 3 Sells.

-when the company reports their fiscal Q4 on Aug 10th, investors will be eagerly awaiting news regarding the restructuring, and any evidence of a business turn.

-for investors who are chasing performance on the long side, names like CSCO could be alluring as it is so close to 52 week and multi-year lows, as opposed to names that have already made match 52 week highs or quickly approaching them…..

-Additionally, with this dramatic turn in the market, analysts who have been right to be cautious on the name could be enticed to do a victory lap and be more constructive and upgrade ahead of the potential turn.

MY VIEW: I would be shocked if the company was not able to finally be slightly more positive than they have been in the past few quarters. And any actual signs of recovery, and upside to guidance this stock will be back above 18 in a quick……

-Current consensus has earnings and sales only growing about 7% for their fiscal 2012….any upside to current estimates could easily call for multiple expansion with the stock currently trading at about 10x next years estimated earnings at the very low end of its historical range.

-Vols look fair with 30 day at the money implieds at about 27.50 vs the 30 and 60 day realized vol at about 25.5 and 23.5 respectively.

-Stock has been a big mover as you would expect the day following the last 4 earnings announcements with an avg move of about 11%.

-If the market continues to rally and make new highs the rally will have to broaden out (they can only buy so much AMZN, NFLX and CMG for goodness sakes).   Eventually guys will get to taking a shot on laggards like CSCO.  I think there is a good chance this stock could be back at $17 in this scenario before earnings.

-technically the chart has a lot of room to run with stock currently well below it’s 20o day moving average of ~$19 and just now approaching an important support resistance level dating back to the throes of the financial crisis.

[caption id="attachment_3110" align="aligncenter" width="300" caption="1 Yr CSCO chart provided by"][/caption]


TRADE: CSCO $15.95 Buy the Aug 17 Calls for .25

-Break-even at 17.25 on Aug Expiration, stock btwn 17 and 17.25 lose up to .25 and below lose all .25 (or 1.5% of the underlying).

-If stock rallies into the even I will look to leg into a call spread as we approach Aug 10 and lock in gains, or reduce the chance of loses.