Cisco Systems stock has a ton of uncertainty, this investor says

A tough macro environment is cause for concern among fans of high tech giant Cisco Systems (Cisco Systems Stock Quote, Chart, News NASDAQ:CSCO), according to John O’Connell of Davis Rea Investment Counsel, who says the company is heading into uncertain times.

Cisco was having a heck of a run earlier this year when it climbed 34 per cent over the first seven months, but the last few have been less rosy as the market has responded negatively to the company’s last couple of quarters and, more directly, to management’s lowered guidance.

The latest for San Jose-based Cisco was its fiscal first quarter delivered on November 13, which met analysts’ forecasts on revenue at $13.16 billion, a one-per-cent increase on an annualized basis, and even surpassed expectations on earnings at $0.84 per share in comparison to the consensus $0.81 per share. (All figures in US dollars.)

But it was a slightly gloomier outlook that again was at issue, with management calling for $0.75 to $0.77 per share in earnings for Cisco’s fiscal Q2 and an annualized revenue decline of between three and five per cent. Analysts were expecting on average of $0.79 per share in earnings and a 2.6-per-cent growth rate in revenue.

The stock dropped more than six per cent on the news, a carbon copy of the market’s reaction to the previous quarter’s lowered guidance back in August.

O’Connell, chairman and CEO at Davis Rea, spoke to BNN Bloomberg last Friday and said that while Cisco may be taking steps to address pressures falling on its business, it’s unclear how long it will take for the company to get out from under the cloud.

“Cisco is the fourth-largest component in its index and it’s got a good balance sheet,” says O’Connell. “It’s not as good as it used to be because they’ve been spending a lot of cash buying back stock.”

“They make switches and routers and all kinds of stuff, and that’s a booming business [but] there are two things to be concerned about. First, China makes a lot of these things and I think that Cisco is losing sales inside China and I think that if we continue to have this battle of the titans going on, we’re going to continue to see frictions there and longer-term problems,” he says.

“Secondly, the big users of all this equipment like the cloud computing companies like Amazon, Google and Microsoft are increasingly trying to contain their cost structures and you’re seeing a lot of white box stuff being manufactured. So there’s price pressure and Cisco is going to try to grind its way through that by charging more on the services and software side of the technology,” O’Connell says.

“But whenever a company says that, it gets people nervous because when you’re going to hardware-as-a-service (like Apple might do, as well), there’s always a timing mismatch where your revenues fall off dramatically,” he said. “I think that that’s why the stock is trading down where it is.”

Cisco has been a climber of a stock over the past half decade or more while at the same time paying out a substantial dividend (the yield is currently at three per cent). Year-to-date, CSCO is now up 4.6 per cent.

“We haven’t decided to purchase it yet. I’m a little apprehensive about the company buying back so much of its stock at a time of such uncertainty,” says O’Connell. “When we’re investing in technology in highly competitive, uncertain environments, we like to invest in companies with big, strong cash balance sheets.”