CSCO Fiscal Q4 Preview & Thoughts

by Dan August 15, 2012 9:30 am • Commentary

Event: CSCO reports Fiscal Q4 results after the close tonight, the options market is implying about a 7% move which is shy of the avg of its previous 4 qtr moves of ~8.5%.  The stock has moved 10% or more 5 out of the last 8 earnings reports.

Sentiment:  Wall Street analysts are generally positive on the stock with 31 Buys, 16 Holds and only 2 Sells with an avg 12 month price target of about $21. Short interest sits at about 1% of the float.  Recently the stock received a couple upgrades which has helped sentiment heading into the qtr,  just last week Goldman Sachs upgraded the shares to their “Conviction Buy List” and Piper Jafray raised their rating from Neutral to Overweight.  

Price Action:  Even with the stock’s recent 15% rally, bouncing off of 52 week lows in late July, the stock remains one of large cap tech’s worst performing names down about 5% on the year, and about 19% from the 52 week highs made in early April.

Technicals:  Starting with a 3 year chart, the earnings gaps, most lower, stick out like sore thumb and speak to a trend of poor execution and what appears to be a serial inability to properly forecast their own business which has led to investors shooting first and asking questions later.

[caption id="attachment_15605" align="aligncenter" width="589" caption="3 yr CSCO chart from Bloomberg"][/caption]


Using a slightly shorter time horizon (1 yr below), the stock’s recent 15% or so rally off of the recent lows sets up for possible disappointment into tonight’s print, as the stock did what it could to fill in the entire gap from Q3 earnings, but ran out of steam just prior to resistance.

[caption id="attachment_15606" align="aligncenter" width="589" caption="1 Yr CSCO chart from Bloomberg"][/caption]


Valuation & Fundamentals: CSCO’s growth has come to a screeching halt with sales and earnings only expected to grow in the mid to high at best single digits for the next couple years, its high single digit forward PE reflects this challenge.  Even as CSCO notches fresh records in earnings and sales each new year, the stock makes new valuation lows by many metrics.  The charts below show that on Enterprise Value to Trailing 12 month Sales, EV to Trailing 12 month EBitda, and EV to Trailing 12 month Cash Flow.

[caption id="attachment_15607" align="aligncenter" width="490" caption="CSCO Valuation Metrics"][/caption]


Volatility: The Aug options are above 80 vol with only a few days left in the cycle following earnings. The farther out months stand at around 30 vol which is average historically:

[caption id="attachment_15610" align="aligncenter" width="633" caption="1 yr IV vs HV from LiveVol Pro"][/caption]

The ATM straddle in August is about 1.05 at 85 vol compared to the September straddle of about 1.45 at 32 vol.


Highlights From Analyst Previews: 

Merrill Lynch – Buy -Price Target $24 – Aug 14th Preview:

Expect an line quarter with slight EPS upside
We expect the 4Q to be around the mid-point of the revenue guidance. We believe
relatively solid switching and data center trends could likely translate into higher than our
forecasted 61.5% gross margin, which combined with cost controls could drive a 1-2c
upside to our 45c EPS estimate. We expect the guidance to be on the conservative side,
with margins supported by the recently announced layoffs. However, on the positive
side, we believe the month-to-month growth improved throughout the quarter, which
could provide a ray of light, and a hope for a forthcoming recovery.

Conservative outlook; but NDS & cost cuts drive EPS upside
The June quarter was weak across the data networking sector, and we expect Cisco
to repeat its cautious tone from 3Q, noting weakness in Europe, Government and
carriers, partially offset by better demand in data centers. We expect 1Q2013 revenue
guidance of 4-5% YoY growth, which includes a ~$250mn quarterly contribution from
the NDS acquisition. Ex-NDS, we are looking for only 2.5% YoY revenue growth and
0.5% QoQ decline. While the subdued spending environment is pressuring growth, we
are increasing our estimates on the back of NDS consolidation. Our FY13/14 EPS
estimates increase from $1.96/$2.11 to $2.00/$2.17.

What to do with the stock? Buy on current weakness
We believe IT spending trends are tracking better than previously feared in the current
weak environment. Cisco’s portfolio is healthy, with solid traction for switching, robust
order trends for 10Gb in a market that is still at its infancy, and good traction for the
ASR5k/9k routers. In 2013, the comps get better, with federal trends stabilizing, and
service provider orders possibly improving. We believe concerns over the impact of
SDN will subside as investors get more details on Cisco’s strategy, which we believe
could involve addressing the storage market over time. Cisco’s valuation, at ~5.5x our
FY14 EPS, ex. net cash post NDS, also suggests to us a positive set up for the stock.

JPM – Buy –  Price Target $19 – Aug 13th Preview:

We believe market expectations for Cisco earnings this week are positive after
“channel checks” supposedly indicate better trading conditions. However, we continue
to believe that flipping a coin is a better method of predicting quarterly Cisco earnings
outcomes than channel checks given the diversity of the company’s business.
Enterprise spending looks like it is continuing to decline and we believe there is a
better than even chance that FQ1 guidance is weak as a result. Note that NDS will
need to be added to consensus numbers and, in our updated model, increases FQ1 EPS
by ~$0.01. We keep our positive rating as we believe Cisco’s valuation already
impounds a lot of bad news. Reiterate Overweight.

Macro alarm bells possible again. Cisco has repeatedly been first to flag
weakening enterprise spending trends. Given macro issues are far from solved
globally and the US economy is beginning to show signs of slowing in addition to
material slowdowns in Europe we believe there is a good chance that Cisco guides
conservatively for FQ1 – possibly below our current forecasts.

Increased focus on costs. After announcing another “limited restructuring” of
1,300 employees back on July 23 we believe Cisco may have more to say on its
management of costs this week. We do not expect incremental cost reductions but
do believe management may elaborate on exactly what is being cut.

Expect FQ4’12 at the midpoint of guidance. We forecast FQ4’12 revenues of
$11.59B (Street $11.61B) with gross margin of 62.0%. Our operating margin and
EPS estimates are 27.2% and $0.45 (Street $0.46), respectively.

MY VIEW: Well, I was obviously early a couple weeks back pressing the short (see below), but I am going to stick to my Bearish guns heading into the print.  Following the stock’s rally over the last 2 weeks, investors who are buying in front of fiscal Q1 and 2013 guidance either know something that I don’t or feel that the stock is cheap enough that another cut to forward guidance is in the stock at current levels.

I am hard pressed given the global macro uncertainty and the geographies and verticals that CSCO is most exposed to that CEO John Chambers has the visibility to “call a bottom.”

Check back later as I may once again re-jigger this position to give me better odds of success as I may swap out of my long premium in the Sept 15 Puts and add to my Long Sept 16 puts and may even consider spreading the 16s by selling more of the 15 Puts.   Decisions, Decisions.  I know I have been wrong on this one so far but I think the recent rally dramatically increases the odds for disappointment.




Previous Posts:

3:05 PM EDT – AUGUST 6, 2012 BY  (EDIT)   Trade Update CSCO: Adjusting and Adding to a Loser

Trade Update Aug 6th, 2012:  Since buying the Sept put spread (detailed below) last Thursday, CSCO has rallied 6% and the structure has lost half of its value.  My conviction level and the trade bias has not changed as a result in the almost 3.5% rally in the Nasdaq in the same period of time, nothing has changed other than market sentiment.   I want to go back and remind myself of what I said Thursday in an effort not to treat this current loss as anything more than it is a low conviction trade gone bad in the short term.

From original post:

My View: I want to make a low premium, defined risk directional bet that CSCO misses and guides lower and the stock re-tests the 52 week lows.  I want to be clear here, I would not short a cheap stock like this with some of the positives that I mentioned above, But I will allocate some trading capital to the idea. This is not a high conviction trade as I will need a lot of things to go wrong in a short period of time, but I like the risk / reward set up, risking .35 to make 1.65 if the stock matches the 2011 low following what has been a historically volatile event for the company.

Now I have been doing this a while, and I clearly recognize the fact that if the market is going break through 1400 and possibly make new highs in the days/weeks to come that it will need some broader participation from some large components.  Investors are underweight large cap tech losers like CSCO, DELL & HPQ, and given the relative underperformance of late, and cheap valuations, they are not difficult names for PMs at large funds to add to in an effort to play a little “catch up” with.

My trade, while clearly wrong for the time being, will likely now take a little tweaking to break-even and be profitable.  Some traders I know well (Enis and CC to name a couple) don’t generally like to add to losing positions, but I tend to be a bit more impetuous, especially when I think the stock has moved on air.  At this point with the Sept 13 Puts offered at .03 (I sold them against the 15s at .10), I am going to cover them as they have a 3 delta.

ACTION: CSCO (16.80) Sept 13 Put Buy to close for .03.  Now I essentially own the Sept 15 Puts for .38


But I am also going to Buy Some higher Sept Puts to capture a potentially negative move following earnings.

New Trade: CSCO (16.80) Bought to open the Sept 16 Put for .42, I will look to spread this if and when the stock retreats into earnings.

I know I am being a little undisciplined by doubling down, but I am going to just stick my toe in the water a bit and buy a lesser amount of the Sept 16 Puts than I own of the Sept Puts 15s.  My conviction level isn’t any greater now, but if the company does what I thought they could do last week, the likelihood of a drop in the shares in my opinion increases with the stock higher now.




Original Post: Aug 2nd, 2012: CSCO: Fiscal Q4 Miss and Weak Forward Guidance Should = New 52 Week Lows

Technology shares over the last year or so has been a tale of two cities as it relates to performance (think Detroit=CSCO and Beverly Hills=AMZN).  Those with perceived product cycles no matter how expensive have out-performed, and those who rely on legacy stodgy ol’ tech products for most of their sales have gotten drilled no matter how cheap.

Event: CSCO will report their fiscal Q4 on Aug 15th, and while I don’t have any particular insight into the quarter and guidance for fiscal 2013, my sense would be that they will both be less than stellar.  Options market is implying about a 6.5% move vs the historical avg of about 6.5% over the last few yrs.

Bull Case: Bulls will point to the stock’s 2% dividend yield (which should go up soon), solid balance sheet (net cash position of 38% of their market cap), and valuations well below peers and well below the market multiple, oh and massive buy back that is also only likely to increase as the stock goes lower.

Sentiment: In this market that trades within just 5% of the April multi-year highs, winners are being bought up to new highs and losers are being sold to new lows, without care of valuation.  Wall Street analysts still fairly positive on the name with 30 Buys, 16 Holds and only 2 Sells.

Technicals:  The chart has been in a massive downtrend since the late 2007 top, and not likely to be resolved until we get a massive flush to the low end of the channel.

CSCO 5yr chart from Bloomberg

My View: I want to make a low premium, defined risk directional bet that CSCO misses and guides lower and the stock re-tests the 52 week lows.  I want to be clear here, I would not short a cheap stock like this with some of the positives that I mentioned above, But I will allocate some trading capital to the idea. This is not a high conviction trade as I will need a lot of things to go wrong in a short period of time, but I like the risk / reward set up, risking .35 to make 1.65 if the stock matches the 2011 low following what has been a historically volatile event for the company.

Trade: CSCO ($15.76) Bought the Sept 15/13 Put Spread for .35

Bought 1 Sept 15 Put for .45

Sold 1 Sept 13 Put at .10

Break-Even on Sept Expiration:

-Profits btwn 14.65 and 13of up to 1.65, max gain of 1.65 at 13 or below.

-Losses of up to .35 btwn 14.65 and 15, max loss of .35 above 15