$CSCO Q3 Earnings Preview

by Enis November 12, 2012 2:56 pm • Commentary

Event:  CSCO reports Q3 earnings Tuesday, November 13th after the market close.  The options market is implying about a 6.5% move on earnings, which is quite low relative to the 8-quarter average of 10%, but close to the 4 quarter average around 7%.  

Sentiment:  Wall Street analysts still have relatively rose-colored glasses on with regards to CSCO, with 34 Buys, 15 Holds and 2 Sells and an avg 12 month price target of ~$21.58.  Short interest sits at a very low 1.2%, surprising for a stock with such a weak 3 year performance record.

Fundamentals:  When the company reported their fiscal Q4 back in the middle of August, not only did they beat fairly depressed expectations but they raised guidance above street consensus.  The stock acted like a coiled spring after it had just flirted with new 52 week lows in the weeks prior to the print.

Prior to Q3 earnings in Oct, I think it is fair to say that expectations were running a bit higher for the CSCO as they enter their fiscal 2013, but that all came to a crashing halt given the generally weak capex guidance by U.S. phone carriers in the last couple weeks (AT&T just lobbed off $1 billion of their 2013 budget) and the weak earnings guidance by competitors JNPR, CIEN & ADTN, to name a few.  Aside from the industry specific headwinds, CSCO’s Q1 results and Q2 guidance will likely fall victim to the general malaise for technology spending given concerns by major corporations for the health of the economic recovery, and the uncertainty surrounding the “fiscal cliff”.

Technicals:  CSCO stock is on track for its 3rd straight negative year.  It is one of the few large cap technology stocks that did not participate in the Nasdaq bull market from 2009 to 2012, and it is only $3 from 5 year lows around $14.  The chart has actually exhibited a bit better action in the past year, but nothing to get too excited about.  Here is the 3 year chart:

CSCO 3 yr chart from Bloomberg

A triangle has formed, which suggest long-term decision time for CSCO stock.  A break below 16 or a break above 18, whichever way it breaks will probably signal the next long-term trend for the stock.

Volatility:  There is nothing too surprising about CSCO’s term structure ahead of earnings, since it’s implying an earnings move in line with history.  Perhaps the one interesting aspect of current implied volatility that I noticed is the spread between 60 day implied volatility (yellow line) and 30 day realized volatility (blue line):

IV vs HV from LiveVol Pro

The spread is about the largest it has been in the past 2 years.  Traders are clearly expecting volatility to move higher, even after the earnings move compression occurs (or else 2 month IV would be 2-4 points lower than current levels).

Recent Unusual Activity:  Just this morning, someone sold 16k of the CSCO Jan2013 15 puts at .25, apparently closing, while it also looks like someone closed a Dec 15/19 collar, selling Dec 15 Put and buying the Dec 19 call.  Last week on Nov 7th, one of the largest trades was a buyer of the Dec 19 calls for .20

My View:  CSCO is a very cheap stock trading at about 9x next years earnings that are expected to grow only about 7%.  The company has a rock solid balance sheet with about 55% of their market cap in cash (or 36% net of debt), while they already pay a healthy dividend, yielding 3.3%, the company could clearly raise this dividend and possibly pay a special dividend ahead of the expected increase in capital gains taxes.   My sense is that a slight revenue miss and less than stellar guidance is built into the stock down about 6% ytd, and down about 11% since the start of Oct.  I am not expecting a beat and raise like last qtr, and I think it is fair to say that most data-points point to a less than clear outlook.  The stock seems to be in No Mans Land at $17, pretty much the mid-point of the range since the May break-down.  We will be reviewing potential trades prior to earnings and post anything that looks compelling.