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Technology Stocks : Cisco Systems, Inc. (CSCO)
CSCO 48.42-0.2%9:56 AM EST

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From: Eric5/16/2019 4:47:47 PM
   of 77388
Cisco sees little impact from tariffs, delivers another upside report

11:31 AM ET 5/16/19 |

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The stock market is receiving a lift this morning following solid quarterly reports from two Dow components: namely, Walmart (WMT) and Cisco (CSCO). These reports are helping to take the focus off of trade concerns with China, which have been dominating headlines.

As for CSCO, the networking and IT security company delivered solid 3Q19 results last night, edging out analysts' top and bottom line estimates. EPS came in at $0.78 vs. the $0.77 expectation on revenue growth of 4.0% to $12.96 bln, also above the $12.89 bln forecast.

It guided for Q4 revenue growth of 4.5-6.5%, which equates to $13.34 bln at the mid-point, slightly ahead of the $13.29 bln consensus.

Click here to access the earnings press release.

Heading into the print, concerns were rising that the new hike in tariffs on Chinese goods could impact the company's growth and outlook. In particular, some of CSCO's switches and routers are made in China. This angst helps explain why the stock sank by nearly 8% from the beginning of May through this past Monday.

However, during the earnings call last night, management did a good job easing investors' concerns, stating that only about 3% of its overall revenues now come from China. Over the past several months, the company has reduced its exposure to China, re-working its supply chain and changing its suppliers.

Furthermore, its CEO stated that it already anticipated that tariffs would be increased to 25% from 10% and that this change was already baked into its outlook.

The minimal impact of the tariffs is reflected in the solid results from its core Infrastructure Platform segment (58% of revenue), which was up 5% to $7.55 bln, better than the $7.47 bln expectation.

Within this segment, management credited switching devices as a significant catalyst driven by the continued ramp of its Catalyst 9000 products. Also, healthy demand for SD-WAN boosted its routing product line.

Its security segment was another key contributor to the upside results; revenue in the category jumped by 21%. From a broader sense, CSCO and many other cyber security companies are benefiting from several trends, including the acceleration of emerging technologies like AI, multi-cloud, and IoT.

CSCO's growth was also aided from the integration of Duo Security, which was acquired last October for $2.35 bln. Duo is best known for its two-factor authentication tools, which help employees to securely access applications and platforms through mobile devices.

To put the impact of Duo into perspective, CSCO said that Duo contributed about 40 basis points to its growth this quarter.

Another issue facing CSCO is that some analysts have questioned the quality of its recent upside reports and its growth overall. That's because its yr/yr growth rates have been inflated by the change to 606 accounting methods.

Companies with a lot of deferred revenue, such as those in the software and communications equipment industries like CSCO, have been impacted the most because the new rule states that revenue must usually be booked right away, rather than stretched out over time.

Consequently, CSCO's software-based revenue has seen an artificial bump from the new standards. But as the implementation of the new rules moves further into the rear-view mirror, the effect is becoming smaller. For this quarter, CSCO said that the 606 impact was a positive 1.2%, relatively light compared to other quarters.

As Cisco is a mature $50 bln business, it's very difficult for it to move the needle in terms of growth, but the upcoming transition to 5G is expected to be a meaningful catalyst as communications and service providers upgrade their networking equipment.

This figures to be a more meaningful factor next year. In the meantime, the launch of new subscription-based Wi-Fi 6 access points, the ongoing Catalyst 9000 refresh, and certain price hikes should accommodate growth throughout the remainder of 2019.

Key Takeaways: CSCO's guidance and commentary helped ease concerns regarding the new escalated tariffs on China-made products. The company has done a good job diversifying its supply chain and manufacturing processes away from China, limiting its exposure there.

Due to its sheer size, its growth rates don't spectacular to begin with, but its modest growth rates have been somewhat inflated by new accounting rules and acquisitions. So, to say business is booming probably wouldn't be an accurate description.

However, several emerging technologies such as AI, IoT, multi-cloud, and Wi-Fi 6 position it well to keep growth rates churning higher. Longer term, the transition to 5G should be a meaningful catalyst.

My comments:

Cisco is a mature company very different than when I first went long with a very large position way back in 1992.

5G and other necessary tech buildouts required for it over the next ten years will give Cisco greatly accelerated growth compared to the last 15.

But it won't be explosive like it was in the 1990's when the Internet was in it's infancy.

Those days are over....


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