Cisco: Growth, Income and a "Rock Solid" Balance Sheet

08/28/2020 5:00 am EST

Focus: TECHNOLOGY

Prakash Kolli

Founder and Author, Dividend Power

Cisco Systems (CSCO) plummeted after the dot-com boom and it still has yet to reach the highs of that era. However, it is still the world’s largest vendor of networking hardware and software, observes Prakesh Kolli, income expert and editor of Dividend Power.

The company is highly profitable and generates prodigious cash flow. This has translated into robust share buybacks and a growing dividend. The current yield is roughly 3.4%.

Further, Cisco’s balance sheet is rock solid. That said, the recent quarterly results and outlook were poorly received by the market. The stock price is down about 12% year-to-date and trading where it was in early-2018. I view the stock has a long-term buy for those seeking income and dividend growth.

Today, the company sells hardware and software for switching, routing, data centers, and wireless applications. Cisco also sells software for networking, analytics, collaboration, and security and firewalls. Cisco is ranked 15 in the 2019 Interbrand’s Best Global Brand list. Cisco had $49,301 million of revenue in 2019.

Cisco recently reported decent Q4 2020 results but with a weak outlook. Additionally, the company announced that the CFO was retiring. The stock price plunged nearly 12% in response. It was the largest decline in almost 11 years. However, the negative outlook was largely due to the impact of COVID-19.

Many businesses are reducing spending across the board to preserve liquidity and maintain cash flow. This led to weak demand of Cisco’s Infrastructure Platform products.

However, many businesses now have higher demand on their networks due to telecommuting during the coronavirus pandemic. They will eventually need to upgrade their networks to handle this change. Cisco should be a beneficiary.

As a dividend growth stock Cisco is a relatively new player. The company has raised the dividend for 9 consecutive years making Cisco a "Dividend Challenger".

This is not a long time when compared to some conventional choices for dividend growth stocks. But the rate of dividend increase has been rapid from a quarterly regular cash dividend of $0.06 in 2011 to $0.36 in 2020. The compound annual growth rate or CAGR has been slightly over 13% in the past 5-years.

Cisco pays an annual forward dividend of $1.44 and is yielding approximately 3.4% as of this writing. The current yield is almost double the roughly 1.75% yield offered by the S&P 500 index. The combination of a consistently rising dividend and decent yield should interest most investors seeking income or dividend growth.

Cisco’s trailing dividend safety metrics are excellent. In fiscal 2020, the payout ratio was approximately 54%. The dividend was also well covered by free cash flow. In fiscal 2020, operating cash flow was $15,426 million and capital expenditures were $770 million giving free cash flow of $14,656 million.

The dividend required $6,016 million giving a dividend-to-FCF ratio of 41%. Debt is not an issue from the perspective of the dividend as Cisco has a net cash position. Importantly total debt has declined over the past few years.

Cisco is undervalued at the moment due to the negative outlook. The stock is trading at about 13.7X consensus fiscal 2021 earnings of $3.09 per share. This is well below the earnings multiple of the S&P 500, which is trading at nearly 30X earnings.

In an arguably overvalued market, Cisco offers income and dividend growth at a reasonable valuation. I view the stock as a long-term buy. (For disclosure, Prakash Kolli is long shares of CSCO.)

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