Cisco Earnings: Weak Orders Overshadow Good Results, but We Don’t Share Market Doubts

Cisco Stock at a Glance

• Fair Value Estimate: $56
• Morningstar Rating: 4 stars
• Morningstar Uncertainty Rating: Medium
• Morningstar Economic Moat Rating: Wide

Cisco Earnings Update

We maintain our $56 fair value estimate for wide-moat Cisco Systems CSCO after the company reported strong third-quarter results. Sales and fourth-quarter guidance beat our expectations, but were tempered by poor order growth that sent shares down roughly 4% after the release. Orders reflect current demand, and they are being negatively affected by a soft macroeconomic environment causing slower customer spending on Cisco equipment.

We aren’t overly concerned with poor order growth in the short term, since Cisco has built a large backlog of orders over the past two years that allows the company to post strong results ahead of underlying orders. We expect Cisco to take roughly a year to work through the rest of its excess backlog, which leaves time for demand to normalize. Looking past rocky short-term demand, we believe Cisco will continue to benefit from healthy long-term networking spending and offering sticky solutions. We think long-term investors should see an attractive entry point at current levels.

Third-quarter sales rose 14% year over year and 7% sequentially to $14.6 billion, above management guidance. Growth was driven by backlog reduction for enterprise networking orders, with the secure and agile networks segment rising 29% year over year. We see similar dynamics with Cisco’s cloud customers, where its internet for the future segment rose 5% year over year. Conversely, we were disappointed by lackluster performance from its security (which rose a paltry 2% year over year) and collaboration (declined 13% year over year) businesses. We believe these segments can rebound, but a soft spending environment has hampered Cisco’s investments that are targeted at inflecting them back to market growth rates.

Non-GAAP gross margin of 65% showed a healthy level and rose by 1% sequentially for the second quarter in a row. We credit Cisco with strong pricing to offset inflation and easing supply pressures for the expansion.