CSCO Fiscal Q3 Earnings Preview

by Dan May 12, 2014 2:12 pm • Commentary

Event:  Wednesday after the close, CSCO will report its fiscal Q3 results.  The options market is implying about a 4% one day move, which is well shy of the avg of the last 4 qtrs of about 8%.

Sentiment:  Wall Street analysts are somewhat positive on the stock, with 27 buys, 17 holds, and 5 sells, though the average 12 month price target is only $24.37.  Short interest is negligible, at just 1% of the float.

Options Open Interest:  Calls outnumber puts by a ratio of about 1.3 to 1.  The single largest strike of open interest falls in May with 100,000 of the May 23 calls, followed by 78,000 of the Jan 20 puts, 63,000 of the Jan 25 calls, 52,000 of the Jan 25 calls and 50,000 of the May 24 calls.

Price Action/Technicals: CSCO has actually out-performed the broad market in 2014, words that have not been uttered about the stock in a very long while (up 3.5% to Nasdaq down 1%).   The one year chart below shows the stock straddling a fairly important one year support/resistance level, at the bottom end of its May 2013 earnings gap, while consolidating at the high end of the 6 month range:

CSCO 1yr chart from Bloomberg
CSCO 1yr chart from Bloomberg

With the stock just above $23, it is almost smack dab in the middle off the 12 month range between $20 on the downside and just above $26 on the upside.  It is also important to note that since making 52 week and 3 year highs last May, the stock has had 3 consecutive gaps lower following disappointing earnings reports and or guidance.

Volatility Snapshot:  As evidenced by the muted implied move relative to the average over the last 4 qtrs, options prices are not as high heading into the print as one would expect.  The chart below of 30 day at the money IV shows the relative complacency compared to the last few quarterly reports as options prices are well below prior quarters, and rather than heading higher into the print they have actually come in over the last week:

CSCO 1yr chart of 30 day at the money implied vol from Bloomberg
CSCO 1yr chart of 30 day at the money implied vol from Bloomberg


Fundamentals/Valuation:  For the past year CSCO’s results have been hurt by double digit declines in orders from emerging markets, a strained capex environment in North America, and a very slow recovery in Europe.  The company has also faced market share losses in their legacy routing segment from smaller competitors like JNPR, while watching non core businesses under-perform.  Despite the company facing its share of marco headwinds given where their growth is expected, the company also seems to be executing poorly in this challenging environment. 

The good news is that the stock is trading about 11x next years expected earnings that should grow mid single digits.  The stock has a dividend yield of 3.3%, a multi-billion $ share buyback, and 39% of their market cap in cash, 25%, net of debt.  The stock screens as CHEAP with most investors and could be very levered to a pick up in growth in the developing world.

OUR VIEW:  Heading into the quarter expectations are anything but high, with analysts expecting earnings to decline 6% year over year, with sales down about 7% yoy, and most analysts do not expect much more than inline quarter and guidance.  The options market does not expect any fireworks either, but what sticks out to us was a comment by Goldman Sachs in research note dated May 11th:

we expect an upbeat tone from the company as a result of significant new product cycles in routing and switching that we expect to ramp into 2H. In addition, we expect a lot more details on Cisco’s cloud/SDN strategy and customer traction at its analyst day, held alongside its Cisco Live event on May 19-20 in San Francisco.

This is the exact sort of sentiment we are looking for, and the sort that those who buy and sell stocks may not appreciate as much as those looking to trade options around an event.

Given the strength of late of many of CSCO’s large cap tech peers, despite reporting poor results (ORCL back in March, INTC & IBM in April) I am hard pressed to see too many scenarios where CSCO would test support down near the March lows just above $21.   We will take a much closer look over the next couple days prior to the print, but we would be more inclined to play for a catch up CSCO with 2 events in the next 10 days that could help catalyze a move higher.