Will Higher Software Sales, Splunk Deal Drive Cisco Stock Back To $60?

Cisco Systems Inc (NASDAQ: CSCO) currently trades at $47 per share, about 26% below its pre-inflation shock high of about $64 seen on December 29, 2021. The sell-off has been driven by several factors.  Cisco’s product sales have slowed as customers have been focused on installing and implementing, the products purchased over the last few quarters. Moreover, large companies, including cloud service providers and telecommunication players, have been holding back on networking spending amid some economic uncertainty.  Separately, Cisco is also facing competition from smaller networking companies, impacting growth. Over Q3 FY’24, the most recently reported quarter, Cisco saw its revenue decline by almoxst 13% year-over-year to $12.7 billion, with adjusted earnings at $0.88 per share.

Looking at a slightly longer period, CSCO stock has seen little change, moving slightly from levels of $45 in early January 2021 to around $45 now, vs. an increase of about 45% for the S&P 500 over this roughly 3-year period. Overall, the performance of CSCO stock with respect to the index has been lackluster. Returns for the stock were 42% in 2021, -25% in 2022, and 6% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that CSCO underperformed the S&P in 2022 and 2023. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Information Technology sector including MSFT, AAPL, and AVGO, and even for the megacap stars GOOG, TSLA, and AMZN.

In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics.
Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could CSCO face a similar situation as it did in 2022 and 2023 and underperform the S&P over the next 12 months – or will it see a strong jump?

Now, the stock could have considerable potential for gains if it recovers to 2021 levels. Returning to the pre-inflation shock level means that Cisco stock will have to gain about 35% if the stock recovers from $47 currently to its pre-shock highs of $64 per share. A couple of factors could drive Cisco stock higher. Cisco’s push into the recurring revenue model and its increasing focus on cybersecurity, via acquisitions, could help the stock. We also believe that the company will perform better than its big tech peers in the event of a potential economic downturn given its lower valuation and the secular spending trends on digitization and networking.  We value CSCO stock at about $55 per share, which is about 20% ahead of the current market price. See our analysis of Cisco Valuation for a closer look at what’s driving our price estimate for the stock. While Cisco stock is undervalued, we think that the upside for the company in the near term could be limited by a mixed economy and potential headwinds to IT spending. Our detailed analysis of  Cisco’s upside post-inflation shock captures trends in the company’s stock during the turbulent market conditions seen recently. It compares these trends to the stock’s performance during the 2008 recession.

2022 Inflation Shock

Timeline of Inflation Shock So Far:

• 2020 – early 2021: An increase in money supply to cushion the impact of lockdowns led to high demand for goods; producers were unable to match up.
• Early 2021: Shipping snarls and worker shortages from the coronavirus pandemic continue to hurt the supply
• April 2021: Inflation rates cross 4% and increase rapidly
• Early 2022: Energy and food prices spike due to the Russian invasion of Ukraine. Fed begins its rate hike process
• June 2022: Inflation levels peak at 9% – the highest level in 40 years. S&P 500 index declined more than 20% from peak levels.
• July – September 2022: Fed hikes interest rates aggressively – resulting in an initial recovery in the S&P 500 followed by another sharp decline
• October 2022 – July 2023: Fed continues rate hike process; improving market sentiments help S&P500 recoup some of its losses
• Since August 2023: Fed has kept interest rates unchanged to quell fears of a recession, although rate cuts are expected in 2024.

In contrast, here’s how CSCO stock and the broader market performed during the 2007/2008 crisis.

Timeline of 2007-08 Crisis

• 10/1/2007: Approximate pre-crisis peak in S&P 500 index
• 9/1/2008 – 10/1/2008: Accelerated market decline corresponding to Lehman bankruptcy filing (9/15/08)
• 3/1/2009: Approximate bottoming out of S&P 500 index
• 12/31/2009: Initial recovery to levels before accelerated decline (around 9/1/2008)

Cisco and S&P 500 Performance During 2007-08 Crisis

CSCO stock declined from nearly $33 in October 2007 to $14.50 in March 2009 (as the markets bottomed out), implying that the stock lost over 55% of its value through the drawdown. However, the stock rebounded strongly to $24 by early 2010. The S&P 500 Index saw a decline of 51%, falling from levels of 1,540 in September 2007 to 757 in March 2009. It then rallied 48% between March 2009 and January 2010 to reach 1,124.

Cisco Fundamentals Over Recent Years

Cisco revenues have risen from around $49 billion in 2020 to about $57 billion in FY’23, driven by higher software sales and demand for networking equipment. While the company posted a net income of about $2.65 per share in 2020, it picked up to $3.10 per share by FY23. However, Cisco has moved from having a net cash position to being a net debt company with close to $32 billion in debt as of the last quarter, as it funded its $28 billion deal to buy Splunk with a mix of cash, commercial paper, and long-term debt.

Conclusion

With the Fed’s efforts to tame runaway inflation rates helping market sentiment, Cisco stock has the potential for gains once fears of a potential recession are allayed.

[1] Returns as of 6/26/2024
[2] Cumulative total returns since the end of 2016

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