Update 1: CSCO Trade

by Dan February 9, 2012 9:24 am • Commentary

Update: Feb 9th 2012 at 9:25am

CSCO saw an initial pop on its earnings in after hours trading, up nearly 4%. That strength turned quickly to a little weakness as the conference call commenced. This morning pre-market the stock is down about 1% from yesterday’s close. Here’s Barron’s:

Cisco forecast revenue to rise 5% to 7% this quarter from last year’s level. With year-ago revenue of $10.87 billion, that would equate to $11.41 billion to $11.63 billion. That is comfortably ahead of the average $11.46 billion estimate.

On the call, one analyst observed that the forecast for this quarter implies revenue will not grow at all, which is contrary to typical seasonal patterns where Cisco has seen a lift in the April quarter.

Chambers, in response, said the company was simply being prudent given economic concerns, and that the outlook was still better than that of competitors who were slashing their outlook

What I’ll look to do is cover the Feb calls at some point for next to nothing. I’m going to put in a 5c bid to cover. If the stock starts to rip I could pay up. Once those are covered the trade sets up well for any strength in the stock between now and April.


Update Feb 8th 2012 at 3:25pm:  Here is the deal, I think the likelihood of a big disappointment here is not great. That said, expectations aren’t exactly low heading into tonight’s print.  I think any premium committed to a long trade around earnings should be done so sparingly as I see a strong likelihood that the move is a non-event.

The quarter was likely OK, not great though as the data points that we got from competitors like JNPR last month weren’t exactly great… But the stock is cheap and investors love big tech right now, and where the easy money might have been made in some of CSCO‘s large cap tech peers, this one is still down about 10% from it’s 52 week highs…..

MY TRADE: I want to fade a potential rally and set up for the stock to re-take last year’s highs after the market sees a little pull back and CSCO bases a bit more around $20.

CSCO ($20.31)  Bought the Feb/ April 21 Call Spread for .28

-Sold 1 Feb 21 call at .38

-Bought 1 April 21 call for .66

Max Risk .28

Bloomberg CSCO Preview: report 2Q today~4:05pm:

• 2Q adj. EPS est. 43c (41c-46c)
• 2Q rev. est. $11.2b ($11.1b-$11.5b)
• 2Q gross margin est. 61.8% (61.2%-62.4%)
• 3Q adj. EPS est. 45c (42c-48c)
• 3Q rev. est. $11.5b ($11.2b-$11.8b)
• 3Q gross margin est. 61.7% (61.2%-61.8%)

• CSCO likely to report in-line qtr, forecast; CSCO a “safe haven” in sector: Morgan Stanley, Feb. 6
• Capex pressure which may weigh on service provider order growth could be offset by healthier enterprise spending; CSCO likely to gain routing shr; may see strength in Federal: JPMorgan, Feb. 6
• Service provider near-term weakness is well known, AT&T, Verizon expect 2012 capex flat to down; investors likely to overlook weakness as they did for Acme Packet, Juniper: Barclays, Feb. 6

• CSCO has beaten adj. EPS last 8 qtrs, beaten rev. 4 of last 8 qtrs, shrs have fallen day after 5 of 8 qtrs
• CSCO up 12% YTD vs. SPX up 7%


Original Post Feb 8th, 2012: 

CSCO ($20.30)   No New Trade at the moment, wanted to post some thoughts, will update with trade ideas later in the day.

-Company reports their fiscal Q2 tonight after the bell, and after a string of earnings disappointments in 2010 into 2011, the company got of the schneid in Aug when they reported their fiscal 2011 Q4.  Since then the stock is up close to 50%, which was also aided by a slight beat and raise in Nov when they reported their f12 Q1.  [private]

Technically, the chart has come full (I mean half) circle, almost completing a massive head and shoulders bottom as it attempts to fill in the earnings gap from Nov 2010.

[caption id="attachment_8678" align="aligncenter" width="300" caption="15 Month CSCO chart from Bloomberg LP"][/caption]


-The options market is implying about a 6.5% move, which seems a bit punchy, but when you consider that the stock has moved about 10% over the last 4 qtrs and about 8.5% over the last 8 qtrs it seems kind of reasonable.  The Options market has clearly underestimated the potential magnitude of the post earnings move over the last 2 years and this qtr could be the same.

[caption id="attachment_8681" align="aligncenter" width="300" caption="last 4 qtrs in and around CSCO earnings from LiveVol Pro"][/caption]


-Wall Street analysts remain fairly positive on the name with 27 Buys, 18 holds and only 1 Sell with an avg 12 month price target of about $22……I have to assume that many of those Holds are looking for reasons to slap a buy on the stock as it looks to play catch up with some of its large cap tech peers like INTC, MSFT and IBM.

-On a Valuation basis the stock is clearly cheap on expected earnings, trading at about 11.3x fiscal 2012, vs JNPR that trades at 23x.  I guess a better comparison would be to INTC, MSFT and ORCL which all trade btwn 11 and 12x this years earnings, but there is one huge difference, CSCO is expected to grow earnings this year by about 10% vs INTC and MSFT expected eps growth of only 2% and ORCL at about 6%.

-Traders/investors appear to be running fairly bullish into the print as the 5 most active options yesterdaay where the Feb 22 calls (29k), Feb 21 calls (21k), Feb 20 calls (18k), Feb weekly 20 calls (11k) and the Apil 20 calls (7600) traded….now it is hard to tell if these were all bought, some tied to stock, others could have been used to over-write longs etc, but call volume ran almost double put volume….

A Couple Analyst previews:

JPM preview note:

CSCO FQ2’12 Preview: Carrier Weakness a Risk but Diversification Provides
Some Insurance, Rod Hall, CFA: Similar to FQ1’12, we head into Cisco’s FQ2’12
earnings with lingering concerns regarding service provider spending. However,
Cisco is more diversified across service providers than many of its competitors. At
the same time, enterprise spending appears to be holding up better than expected and
we believe Cisco’s renewed aggressiveness and product refreshes are making things
tougher for its competitors. Even with volatile CapEx trends, we expect Cisco to be
relatively better off than its peers and continue to favor the stock considering
potential margin and earnings upside. We project revenues of $11.19b (Cons. =
$11.23b) with gross margin of 61.8%. We model operating margin at 26.2% (Cons.
= 26.4%) and EPS of $0.43 (Cons. = $0.43). We maintain our Overweight rating.

Credit Suisse Preview:

We reiterate our OP rating and continue to see favorable risk-reward in CSCO’s shares. Margins appear to have stabilized over the past 3 – 4 quarters. While mix shift and comp likely to lead to further long-term erosion, we think relatively stable to improving GM and improving oper margin is more likely in the near-term as CSCO drives further incremental improvement in its switching and routing GM and gains benefits of staff reduction. CSCO’s growth should benefit from previous “low-bar” guidance reset; depressed year ago levels providing easy growth comps as move throughout the balance of FY12 and into FY13; improved product portfolio, competitive position and GM in its key enterprise
switching and carrier routing markets; on-going gains in UCS and Telepresence; and follow-on to the initial growth rebound in its security business. As for competition, we see CSCO as a larger issue for JNPR and HP during this timeframe than the other way around.

Near-term. For those who simply must know, we expect CSCO to report solid to strong FY2Q12 operating results andFY3Q12 guidance and outlook. Our industry checks and public datapoints suggest that enterprise IT spend (two-thirds of revenue) has held up surprisingly well. While JNPR and a number of other suppliers recently cited weak North America Carrier CapEx for challenging outlook, we believe CSCO has significantly less leverage to Tier 1 U.S. carriers and has relatively stronger product cycles in ASR5000, ASR9000 and CRS3.

MY VIEW: there is clearly a lot of good news in the stock up 12% ytd and up more than 52% from its Aug lows.  Expectations aren’t exactly downbeat heading into the print and I think there can be a strong case to be made for stock replacement strategies at current levels.

Check back later for new trade ideas.