$CSCO Fiscal Q3 Earnings Preview

by Dan May 13, 2013 2:52 pm • Commentary

Event: CSCO reports their fiscal Q3 earnings Wednesday May 15th after the close.  The options market is implying about a 4.6%* move vs the 4 qtr avg move of ~6.4% and the 8 qtr avg move of ~6.77%.  (* with the stock ~$21, the May 18th 21 straddle is offered ~$1.05, if you bought that you would need a $1.05, or 4.75 move by Friday’s close to break-even.)

Historical Quarterly Earnings and % Moves:

eps est reported % move
2/13/2003 0.48 0.51 -0.71
11/13/2012 0.46 0.47 4.81%
8/15/2012 0.455 0.39 9.63%
5/9/2012 0.466 0.476 -10.49%
4 qtr avg 6.4%

data from Bloomberg

Sentiment:  Wall Street analysts are generally positive on the stock with 37 Buys, 10 Holds and 4 Sells with an avg 12 month price target of ~$24.  Short interest sits at only 1% of the float.

Options Volumes / Open Interest:  Open interest is heavily skewed towards calls, with the Put Call ratio at about .72.

Two of the largest individual lines of open interest are in May18th expiration:  101,000 of the May 21  calls & 87k  May 22 calls.  The next largest lines are in Jan2014 with 72k of the 22 and 25 calls each.

Price Action / Technicals:  CSCO has been stuck in a 10% range all year trading btwn $20 and $22, and now sitting right in the middle.  The stock’s ytd performance of almost 8% lags that of the Nasdaq’s 14% ytd gains and other large cap old  technology stocks like MSFT (up 22%) & INTC up (17%).  Zooming out to the 5 year weekly chart, the stock is right in the middle of its longer-term range as well:

5 year weekly chart of CSCO, Courtesy of Bloomberg
5 year weekly chart of CSCO, Courtesy of Bloomberg

The 5 year range for CSCO is between 13.30 and 27.74, so the stock around $21 is right in the middle of that range.  On the 1 year chart, the obvious levels to watch are $22 for resistance (red line), and support around the 200 day moving average (and the 2012 closing price) in black, around 19.65:

1 year daily chart of CSCO, Courtesy of Bloomberg
1 year daily chart of CSCO, Courtesy of Bloomberg

Valuation:  CSCO currently trades at 10.6x expected 2013 earnings which are only expected to grow 8% this year and 6% next.  Analyst expect sales to grow only 6% for the next 3 years.  Despite the company nearing record sales and earnings in fiscal 2013, the valuation as measured by P/E trades near 10 year and all time lows (below).

CSCO 10 yr PE chart from Bloomberg
CSCO 10 yr PE chart from Bloomberg

CSCO falls into the “stuck in the mud” cheap ol’ tech category, that has been in vogue of late as there appears to be a rotation out of defensive names and into more cyclical sectors.   What they lack in organic growth opportunities,  they make up for in balance sheet (41% market cap in cash, 26.5% net of debt), and cash re-payment to shareholders (pays a dividend that yields 3.22% & a massive multi-billion share repurchase).

Vol Snapshot:  The chart below shows that implied vol (blue line) has come in a tad into tonight’s print, as realized vol (white line) has picked up a bit, trading at levels higher than its last 2 reports.

CSCO 30 day IV vs 30 day Realized from Bloomberg
CSCO 30 day IV vs 30 day Realized from Bloomberg


Expectations: IN a note to clients from this morning, GS, who rates the shares a Buy, had the following preview:

Expect solid quarter with EPS upside on stronger gross margins – We expect Cisco to deliver a solid quarter, with our F3Q (Apr) revenue estimate at $12.17 bn (up 5.0% yoy), a touch below consensus at $12.19 bn, and at the mid-point of guidance for 4-6% yoy growth. We believe there is little disagreement around the F3Q sales number, as Cisco guided conservatively and already reflected in its guidance the weakness in the federal vertical (~4% of product sales). Our F3Q EPS estimate of $0.50 is above consensus at $0.49 and at the high end of guidance for $0.48-0.50, with the upside driven by gross margins, which we model at 62.5% vs. FactSet consensus at 61.9% and guidance of 61-62%. This is up from 62.3% in the January quarter, but down from 63.1% in the year ago April quarter.

We expect the gross margin upside to be driven by continued value engineering and cost reductions led by COO Gary Moore, who commented at an investor conference in February that he is targeting COGS reductions of around $900 mn (implying 180bps of gross margin), compared to $800 mn last year. Cisco has already demonstrated a solid track record with its cost reduction initiatives, exceeding its gross margin guidance and Street expectations in each of the last 7 quarters. Moreover, we see a favorable mix shift from a sequential perspective, as we model a 10% qoq decline in the server segment (well below-average gross margins), consistent with normal seasonality and weak results in that market by IBM and Oracle, vs. a 3% qoq increase in routing sales (above-average gross margins) off a weak January quarter.


My View:  There has been a lot of talk of late about the rotation out of defensive sectors like Utilities and Staples into more cyclical sectors like Industrials and  Technology.  While there are obvious beneficiaries of this supposed trend (AAPL, INTC & MSFT) there are some high profile examples of stocks that have not budged, ORCL, JNPR and CSCO to name a few.  CSCO’s lack of participation of late would make me a tad worried if I were long the stock here as a I don’t see a heck of a lot of difference btwn INTC and CSCO from a value investor standpoint or for those looking to pick up laggards.  Something has to give here, and frankly I am not exactly sure what that is.

A couple weeks ago I bought the May 21 Straddle when the stock was right about here, it has since decayed a little but I liked the prospect of owning the move in front of what I thought could either be a rotation in the stock and result in a pop like the ones some of its old tech peers have enjoyed in the last month, or be subject to a broad market move lower.  I will not likely hold this position into Wednesday’s earnings and may look to adjust or roll out into something else to express a directional view.  Stay tuned.