Networking hardware giant Cisco Systems (CSCO 1.26%) beat analyst expectations across the board with its quarterly report last week, but the stock was punished, nonetheless. Revenue plunged 13% year over year even with some help from the acquisition of Splunk, and earnings declined by a similar amount.
The inventory correction may be wrapping up
Cisco has been pushing to increase recurring revenue and lower its dependence on one-off hardware sales. Revenue from subscriptions accounted for 54% of total revenue in the fiscal third quarter, which ended on April 27. That figure was boosted a bit by the acquisition of Splunk.
Despite all this recurring revenue, Cisco is still sensitive to the buying patterns of its customer base. The company's revenue suffered in the third quarter because its customers were overloaded with products yet to be installed. This excess inventory led to fewer orders in past periods -- orders were down 12% year over year in Cisco's second quarter.
The good news is that product order trends have improved. Total product orders were up 4% year over year in the third quarter including Splunk and flat excluding Splunk. Cisco expects its customers to largely complete installing existing product inventories by July, so product orders should recover further later this year.
Revenue will still be down significantly in the fiscal fourth quarter even with additional revenue from Splunk. Cisco expects to produce revenue between $13.4 billion and $13.6 billion, down about 13% year over year. Excluding Splunk, revenue would be down a whopping 18%.
With product orders bottoming out and the inventory correction nearly over, Cisco's fiscal year that kicks off in August should look a lot better than the current fiscal year. It takes time for product orders to translate into revenue, but a return to year-over-year revenue growth should be coming relatively soon.
Is Cisco stock a buy?
Ups and downs are nothing new for Cisco. The company is sensitive to economic conditions as well as customer buying patterns. While Cisco sells critical networking infrastructure, purchases can be delayed during times of belt-tightening for its customers.
Cisco expects to produce adjusted earnings per share between $3.69 and $3.71 in the current fiscal year. That works out to a price-to-earnings ratio of about 13. The consensus analyst estimate calls for a slight earnings decline in fiscal 2025, so the stock is slightly more expensive on a forward price-to-earnings basis.
Cisco stock certainly appears inexpensive, but the company does face some real challenges. Cisco remains the dominant player in the switching and routing markets, but competitors are gaining ground in some areas. Arista Networks in particular is proving to be a thorn in Cisco's side. In the 10GbE and higher portion of the data center switching market, Arista has nearly caught up to Cisco in terms of dollar-based market share.
Cisco's earnings can grow quickly at times, but on average, the company will likely be a slow grower at best. Cisco's valuation is low enough that slow growth can still translate into decent returns for investors in the long run, and a 3%+ dividend yield will help the cause.
Cisco stock probably won't trounce the S&P 500 Index, but it looks like a decent long-term investment for those unwilling to pay lofty premiums for faster-growing companies.
