Cisco Slides on Weak Outlook, Dragging Down Other Enterprise IT Stocks -- Barrons.com
By Eric J. Savitz
Cisco Systems shares are headed for their worst one-day decline in more than nine years, after the company provided disappointing guidance for its October quarter, as the economic fallout from the Covid-19 pandemic continues to weigh on the networking giant's business.
In trading Thursday afternoon, shares of Cisco (ticker: CSCO) were down more than 11%, to $42.64. Worried investors also sold off shares of other hardware-driven enterprise IT stocks.
Cisco's July quarter results were less than spectacular, but were well within expectations. Revenue was $12.2 billion, down 9% from a year ago, within the company's guidance range of down 8.5% to 11.5%, and a little above the Wall Street analyst consensus of $12.1 billion.
Non-GAAP profits were 80 cents a share, down 4% from a year ago, but above the Street's forecast of 74 cents and ahead of the company's guidance range of 72 cents to 74 cents.
But here's the thing. As Cisco (CFO Kelly Kramer noted in an interview with Barron's on Wednesday, Wall Street analysts heading into the announcement were hopeful that the July quarter would market a bottom in IT infrastructure demand -- and that guidance would show some hints of recovery. But that's not what happened.
"The environment hasn't really gotten better," she said. Indeed, for the current quarter, Cisco is projecting revenue to be down 9% to 11%. At the middle of the range, that would be a 10% drop, slightly worse than the July quarter; the Street had been looking for a decline in the 7% range. Overall orders in the quarter were down a disappointing 10%, and commercial orders -- basically smaller customers -- were down 23%.
There are multiple contributing factors to Cisco's weak outlook. One is simply that the economy is extremely weak. Kramer notes that demand held up at the very largest enterprises, and public sector was a bright spot, but there was softness almost everywhere else, covering companies in every geography, of every size and across almost every product line.
Some of the issues are internal, however, and relate to Cisco's still considerable reliance on revenue from routers, switches, and other hardware products at a time when there is growing adoption of cloud computing and many customers are cutting IT budgets.
Cisco announced plans for a $1 billion cost-cutting program that almost certainly will include layoffs, although Kramer says she hopes that a lot of that can be accomplished through voluntary retirement programs. The company also said it would redirect its R&D dollars to focus on faster growing areas of its business, including cloud-based security and collaboration, enterprise automation, 5G, WiFi6, and other emerging trends. And Cisco said it intended to accelerate the transformation of its business to be driven by software rather than hardware.
There were some offsets to all the bad news. The company continues to see strong demand for its security software segment, and there was double-digit revenue growth at WebEx, the company's videoconferencing arm. But overall, the results left the Street disappointed, and the stock is suffering as a result.
In July, J.P. Morgan's Samil Chatterjee downgraded Cisco shares to Neutral from Overweight, citing a lack of visibility on a return to revenue growth amid continued economic headwinds for enterprise IT spending. (Nice call.) On Thursday, he repeated his cautious stance, while cutting his target price to $46, from $50.
"While most companies that have reported this earnings season have cited calendar Q2 as the trough and guided to improving trends through the remainder of the year, Cisco's worsening order trends are limiting the sequential recovery," he writes. "In addition to a sluggish recovery in Enterprise IT spending trends, Cisco's portfolio of products, which are still heavily aligned to on-premise IT investments from enterprise and SMB customers, are facing both near-term as well long-term architectural challenges."
William Blair analyst Jason Ader sees signs of deep structural issues. "Cisco is facing a crossroads moment in its business that was not caused by the pandemic but is being exacerbated by it," he writes. "Put simply, we believe Cisco missed a golden opportunity to fundamentally reshape its business post tax-reform/repatriation, instead opting to repurchase nearly $37 billion in stock in 2018 and 2019. Now with sky-high valuations for growth assets, we worry that it is too late."
Ader adds that the pandemic is spotlighting the fact that while Cisco has made some progress in shifting to higher-growth software and cloud revenue, it remains heavily dependent on hardware and on-premises revenue, with almost 60% of product revenue still tied to traditional switching and routing, down only modestly from 80% 15 years ago. "With the pandemic accelerating underlying digital transformation trends, the warts in Cisco's product portfolio are becoming more visible," he writes.
Wells Fargo analyst Aaron Rakers thinks the results bode poorly for other companies selling "on premise" enterprise technology products, like HP Enterprise (HPE), Dell Technologies (DELL), NetApp (NTAP), and Pure Storage (PSTG). And all of those stocks were trading lower Thursday.
HP Enterprise was down 4.4% in trading Thursday, NetApp was off 3.2%, Pure Storage, down 2.6%, Dell, off 1.8%, and IBM was 1% lower.