Cisco Systems (NASDAQ: CSCO) is a long-term play on AI that investors should heed. Its AI abilities aren’t rooted in GPUs, CPUs, and the training of AI but in the long-term application. AI applications, including agents, assistants, voice interfaces, and other generative models, are the next step and will depend on Cisco's internet infrastructure and networking tools.
AI applications will be the largest and fastest-growing segment of AI, which is saying a lot in light of NVIDIA’s (NASDAQ: NVDA) sustained triple-digit growth. Cisco Systems is well-positioned to benefit from the infrastructure growth and support needed to operate AI services, and its business turned a corner in late 2024.
Cisco Systems Business Contraction is Over
Cisco’s FQ1 results aren’t stellar, with revenue shrinking by 6%. Still, the $13.84 is better than the consensus forecast by MarketBeat and other factors, including guidance, favor a return to year-over-year growth in FQ2.
The acquisition of Splunk primarily drove the outperformance, but even adjusted for it, the outlook is for core growth to resume in both segments in Q2. The product segment contracted by 9% in FQ1, while the services segment grew by 6%.
The margin news is also good despite the YOY contraction. Gross margin improved in all internal comparisons on a GAAP and adjusted basis, revealing improved sales leverage. However, the operating expenses increased on increased R&D, marketing, SG&A, and restructuring charges.
The bulk of the spending increases are to fund innovation, drive sales, and sustain growth, which are positives for long-term investors, and the net result was better than expected. The adjusted EPS contracted at an accelerated rate, but the adjusted $0.91 is $0.04 better than the analysts' consensus, and margins are expected to remain solid.
The guidance for Q2 and the year isn’t robust. However, it aligns with the outlook for top-line growth to resume in Q2 and be sustained through the year’s end, and the company may be cautious in its estimates.
The full-year target range is only expected to grow by about 3% despite the 20% increase in product orders and products accounting for more than 70% of revenue in Q1. With economic headwinds expected to ease as interest rates fall and for business tailwinds to build when Trump takes office, guidance will likely be increased as F2025 progresses.
Cisco Systems Cash Flow Sustains Healthy Capital Returns
Cisco Systems' investment thesis includes a healthy capital return with a growing distribution. The company’s dividend will be worth $1.60 in 2024, about 2.7%, with shares near $58 and cheap to own at only 16X earnings. The payout is reliable, less than 50% of adjusted earnings, and the distribution has increased for 13 consecutive years.
The balance sheet is a fortress, and the cash flow is positive and expected to grow, so it can sustain annual increases and buybacks. Buybacks favor shareholders, reducing the count by an average of 1.8% in Q1 and can be expected to continue in future quarters. Regarding the balance sheet, assets declined slightly but were offset by a decline in liability, leaving equity flat and long-term leverage under 0.5X.
Analysts Sentiment Warms, Creates Updraft for Share Prices
The analysts’ response to Cisco’s Q1 results is promising. MarketBeat tracks numerous price target increases that align with the consensus or are higher and support the uptrend in the stock. However, the consensus target in mid-November is close to $59, assuming the market is fairly valued and the high-end range isn’t much better. The high-end range adds 3% to 5% to that figure and may cap gains in 2024 because it aligns with significant technical resistance. Significant technical resistance at the low $60s may not be broken until sometime in 2025 after proof of the company’s return to growth and growing momentum.
