The technology sector is experiencing a renaissance propelled by the advent of artificial intelligence (AI). The promise of cutting-edge AI applications disrupting multiple industries has sparked widespread excitement and optimism.
However, Cisco Systems (NASDAQ: CSCO) finds itself on the periphery of this transformative wave, struggling to ride the coattails of the industry’s rapid evolution. Recent lackluster growth trends have applied pressure on the stock, with a 19% decline from its yearly peak.
Despite these surface-level challenges, a closer examination reveals glimmers of hope. Cisco’s optimistic stance, underpinned by the potential of emerging AI-centric networking and security prospects, offers a ray of possibility.
Assessing the Varied Financial Landscape of 2024
Recognized as a stalwart in networking connectivity, Cisco Systems predominantly deals in hardware like routers, switches, and wireless access points.
Although these products remain integral to the company’s operations, a dip in networking segment sales this year follows a robust 2023 performance fueled by backlog fulfillment. A 13% decline in total revenue for the third fiscal quarter (ending April 27) resulted from customers working through surplus inventory.
This revenue downturn was mirrored in the non-GAAP earnings per share, which dropped from $1 in the previous year to $0.88 in Q3, elucidating the stock’s tepid 2024 display.
However, the narrative takes a positive turn with a shifting business model inclining towards interconnected connectivity and security software. Software now contributes 35% of total revenue, showcasing a steady rise from 30% two years back. Notably, a significant share of the revenue now stems from subscription-based models, enhancing profitability. Q3’s non-GAAP gross margin ascent to 68.3% from 65.2% in Q3 2023 paints a promising trajectory. Cisco’s Annual Recurring Revenue (ARR) also jumped by 22%, portending future growth and earnings uptick.
Image source: Getty Images.
Laying the Groundwork for Sustainable Expansion
Considering 2024 a transitionary phase, Cisco foresees a brighter future ahead. The strategic focus within networking involves stabilizing core product sales while tapping into the burgeoning demand for infrastructure in AI-enabled cloud computing, cybersecurity, and connectivity solutions. The recent acquisition of Splunk in 2023 bolsters Cisco’s capability in delivering a comprehensive full-stack platform.
The global network offerings are well-positioned to capitalize on existing and new client relationships invested in AI infrastructure and secure networking. Noteworthy is Cisco’s collaboration with Nvidia to ensure compatibility of the latest GPU AI chips with Cisco’s infrastructure, a partnership expected to reflect positively on future financial performance.
Highlighting early achievement with $1 billion in AI product orders slated until 2025, Cisco projects a rebound in growth from the following year onwards. The company eyes mid-single-digit revenue expansion into fiscal 2026 and 2027 while leveraging increased margins for higher EPS.
Image source: Cisco Systems.
Strategizing the Future for Cisco
The appeal of investing in Cisco Systems lies not in meteoric growth or groundbreaking innovation but in its evolution towards a software and services-focused operational model, offering a more robust earnings profile.
In my assessment, Cisco’s trade at a forward P/E ratio under 13 times the Wall Street’s average 2024 EPS estimate of $3.70 is indicative of good value within the tech sphere. Furthermore, Cisco’s 3.4% dividend yield, backed by robust cash flows and a sturdy balance sheet, adds to its investment appeal.
For investors banking on Cisco’s ability to execute its strategies and potentially surpass expectations, owning the stock as part of a diversified portfolio holds promise.
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