Caris & Co. analyst John Slack initiated coverage of Cisco (CSCO) with a Buy rating and $24 price target.
Slack wrote that the bar has been set low, and that the company’s business is inflecting, which could set the stage for top- and bottom-line growth, along with margin stabilization, that would support an expansion of the stock’s valuation.
Read more below:
Estimates Should Creep Higher Over the Next Few Quarters. We believe Cisco estimates should continue to move higher given: 1) Refreshed operating model is achievable and management guidance remains conservative (prudently so, in our view, given the macro); 2) Gross margin stabilizing, while operating margins improve with improved volumes off of $1B in opex cuts already realized this fiscal year. 3) Easy comps through the end of CY2012.
Product Gross Margin Stabilizing & Opex Controls Give Wiggle Room. We believe Cisco’s Switching gross margin returning to a year ago level is indicative that its focus on the core segment is yielding results and moderating competition intensity. In our view, drivers for margin stabilization/improvement both internally (value engineering, sales comp alignment) and externally (“stable” pricing environment) are fundamentally positive.
Cisco’s Competitive Position is Stabilizing. The refocusing of the company back around its core routing and switching franchise, along with key product refreshes beginning to gain steam (Nexus 7K, Catalyst 6500 Sup2T, Service Provider order strength), has allowed CSCO to regain its swagger and outflank the competition (notably HP in the enterprise and JNPR in Service Provider). In addition, pricing pressure in the switching market has stabilized somewhat.
Risks Remain Given Macro, Ongoing Margin and Competitive Pressures. With stabilizing trends both in end-demand and margins, we believe Cisco’s darkest days are behind it. However, the company needs to continue to keep up its solid execution. Concerns remain, but given our view that there is little downside risk to EPS estimates, Cisco’s sizable net cash position (~$5.50/share) and 10% FCF yield, we believe the stock will continue to be a relative safe-haven—even in a difficult macro.
Valuation: Double-Digit EPS Growth Justifies $24 Price Target. Our $24 target is based on applying an 11x multiple to our CY13 non-GAAP EPS of $2.14. Alternatively, this equates to 8x our CY13 ex-cash EPS of $2.12 plus an estimated $7/share in cash in one year. While this target implies multiple expansion during the coming year, we believe this is a reasonable assumption based on our view that Cisco can post double-digit earnings growth over the coming year. Further, this multiple remains at a discount to the S&P500 and Cisco’s large cap tech peers, whereas Cisco has historically traded at 5-10% premium to the market.