Cisco, Long a Steady Tech Stock, Is Under the Microscope Ahead of Earnings

One of the steadiest performers in tech for the past 20 years, Cisco (CSCO) , is scheduled to report earnings on Wednesday. Let's unpack what to expect -- and why some top analysts are flashing a yellow light on the network equipment maker ahead of the quarterly report and amid tightening competition. 

For the past decade, this technology name has been a lumbering giant, with revenues up just over 5% since 2013 from $48.6 billion to $51.2 billion. As product revenue has been mostly flat, Cisco has improved services from 22% of its revenues to 28% currently, accounting for all of its overall growth. The company is a buyback king, reducing outstanding shares from 5.32 billion to 4.14 billion over the last decade, helping earnings to rise 80% from $1.75 to $3.36.

But ahead of the report, analysts from Citi (C) and Morgan Stanley (MS) believe cautiousness is warranted prior to results due to the likelihood of weak guidance for next quarter.

At a 14 price-to-earnings ratio, Cisco is reasonably valued, but Citi's analyst argues that with stronger competition, persistent supply chain challenges, tougher comps, and orders materially slowing, the multiple can compress further. Citi has the only "Sell" rating along with a Wall Street low $40 target. Citi's concerned Cisco is losing share to Arista (ANET) and Juniper (JNPR)  causing inventory woes, noting product order trends have decelerated to 8% from over 30% the past three quarters.

Morgan Stanley's concern is primarily a factor of a more cautious view of the enterprise spending environment. "We lean more cautious into CSCO's FQ4 print as our checks point to little improvement in the supply chain during the quarter and likelihood of downward order growth trajectory on tougher compares."

Morgan is particularly concerned about Cisco's guidance, "We see more risk in the outlook for FQ1/FY23 with revenue likely still gated by limited supply improvement. As such, we are lowering our estimates for FY23 by ~2% on revenue and ~1% on EPS."

Conversely, the bull case rests on Cisco's shares trading at a healthy discount to the market multiple along with continued solid demand trends. Plus, last quarter's highly disappointing guidance likely already captures supply chain challenges. The bullish analyst at Cowen notes, "Our conversations with channel partners and a number of large enterprise customers indicate no meaningful degradation in demand trends and calendar 2Q22 operating results and outlook from virtually all networking equipment companies that have reported to date reflect strong underlying demand trends."

In the five years since John Chambers left the helm at Cisco, management has leaned heavily on more aggressive buybacks to bolster earnings as revenue growth has remained soft. Yet, to fund buybacks, net cash has decreased from about $35 billion to $10 billion.

It's hard to be too negative on Cisco's stock, which will likely perform fine over time -- owing to solid cash flow allowing for large buybacks and a 3% dividend yield -- but competition, sluggish growth, and supply challenges in a slowing global economy can potentially cause near-term shareholder angst. The market has recently been very forgiving of weaker earnings outlooks, so if analysts at Citi and Morgan Stanley are accurate, waiting for a dip to buy after a disappointing earnings report is the prudent way to play Cisco.

At the time of publication, Ginesin had no position in any security mentioned.