$CSCO Fiscal Q2 Earnings Preview

by Enis February 11, 2014 3:02 pm • Commentary

Event:  CSCO reports its fiscal Q2 earnings tomorrow after the close.  The options market is implying about a 6% move, vs. the 4 quarter average of about 7.75%, and the  8 quarter average of about 7.25%.

Sentiment:  Wall Street analysts are somewhat positive on the stock, with 25 buys, 16 holds, and 5 sells, though the average 12 month price target is only $23.71.  Short interest is negligible, at just 1% of the float.  CSCO has been underperforming the broader market for many years now, as the stock is in the exact same spot that it was 15 years ago, 10 years ago, and 3 years ago.

Options Open Interest:  Calls outnumber puts by a ratio of about 1.25 to 1.  The one month average options volume has also favored calls over puts, by a ratio of 1.45 to 1.  Despite numerous gaps on earnings over the past 5 years, CSCO has been rangebound the entire time, so options sellers have generally been on the right side of the trade in the long run.

The followings strikes have over 50k of open interest:

-Feb22nd 22 calls

-Feb22nd 23 calls

-Mar22nd 21 puts

-Jan15 20 puts

-Jan15 25 calls

Price Action/Technicals:  CSCO has been rangebound for more than a decade now.  In fact, the stock has traded between $14 and $35 for all of the past 10 years, and is near the middle of its 10 year range today.

On a daily chart, the stock held $20 support in late 2013 after a bad earnings miss in November, and has rallied up to its declining 150 day moving average around $23.25:

CSCO daily chart, 150 day ma in yellow, Courtesy of Bloomberg
CSCO daily chart, 150 day ma in yellow, Courtesy of Bloomberg

CSCO has had two straight gaps lower on earnings, neither of which have been filled yet.  The first gap from November is $23.99, while the second gap from back in August is $26.38.

Those are the levels to watch on the upside.  On the downside, $20 remains the most important support level, with minor support around $22.

Fundamentals/Valuation:  Cisco has declined sharply after each of the past 2 earnings reports.  Management has blamed a weak international macro environment (CSCO gets about 40% of its revenues from abroad) and a production transition for the weakness.  As a result of the consecutive misses, the bar for this week’s report is quite low.

However, the macro environment in emerging markets in particular is likely worse today than it was last year.  While many large-cap tech companies have reported improved demand in enterprise spending over the last couple months (ORCL, RHT, JNPR, etc.), CSCO might have benefitted less from that pop because its ongoing product transitions.

Guidance will be crucial since analysts are modeling a better second half of the year.  CSCO trades at 12x earnings, with earnings growth of about 5% expected over the next couple years.  Its strong balance sheet and 3% dividend attract the conservative investor base.  More tepid earnings growth over the next 12 months, though, would likely mean more rangebound price action for CSCO going forward.

Volatility:  Implied volatility in CSCO has been very consistent over the past 2 years, rising into the earnings event into the 30’s, and then selling off to into the high teens after the event:

30 day implied vol in CSCO, Courtesy of LiveVolPro
30 day implied vol in CSCO, Courtesy of LiveVolPro

We anticipate similar behavior this time around as well.  CSCO stock usually calms down after the earnings move, though the actual earnings gap can be quite large.

Estimates from Bloomberg:

  • 2Q adj. EPS est. 46c (range 45c-47c), 45c-47c forecast reaffirmed Dec. 12
  • 2Q rev. est. $11.03b (-9% y/y), forecast -8% to -10% y/y
  • 2Q gross margin est. 61.9% (range 61.4%-62.5%), forecast Nov. 14 61%-62%
  • 3Q adj. EPS est. 48c (range 45c-50c)
  • 3Q rev. est. $11.34b (range $10.95b-$11.84b)
  • 3Q gross margin est. 62% (range 61.2%-62.5%