Cisco FQ1 24 – The hangover

Cisco serves as a warning to everyone else.

• Cisco’s efforts to reduce revenue volatility have come unstuck as a normalisation of client activity in hardware after a period of real strength hammered both revenue guidance and the share price.
• FQ1 24 revenues / EPS were $14.7bn / $1.11 ahead of estimates of $14.6bn / $1.03 but this was where the good news ended.
• For the last few quarters, concerns around supply have caused Cisco’s customers to buy more products than they otherwise normally would.
• These concerns have now been alleviated meaning that customers are comfortable that they will be able to procure what they need in good time and consequently, they have normalised ordering patterns.
• The net result is that orders have declined materially and will remain depressed until client inventory has returned to historically normal levels.
• Cisco estimates that its clients are carrying 1 to 2 quarters’ worth of elevated inventory and are focusing on deploying what they have before buying any more.
• The net result is that FQ2 24 revenues are expected to be $12.6bn – $12.8bn ($12.7bn) well short of the $14.2bn expected which is exacerbated by the fact that calendar Q4 is usually seasonally strong due to the budget flush effect.
• Pricing is not a problem as gross margins are unaffected by the weaker revenues, but EPS will also suffer as it is now expected to be $0.82 – $0.84 compared to consensus at $0.99.
• Needless the say, the market was not pleased with this turn of events and sent the shares down 16% in after-hours trading.
• The problem that Cisco has been struggling with for years is that it is a turns business meaning that it does not operate on long-term supply contracts.
• This means that when customers change their ordering patterns, Cisco feels it immediately which is why these results should serve as a warning for other IT equipment suppliers to companies.
• So far in 2023, the enterprise IT sector has been relatively resilient against the poor macro environment, but these numbers are a warning that there be some weakness coming for Cisco’s peers.
• For example, Palo Alto Networks also reported weak guidance, but it put this down to the higher cost of borrowing putting pressure on companies’ ability to finance purchases.
• I suspect that there is an element of this in Cisco’s weakness as well even if the company does not wish to admit it.
• The net result is that there are signs of the brakes being put on enterprise spending outside of a few core areas such as generative AI and cybersecurity to name two.
• Hence, I think that there is a good chance that the next few quarters see some disappointing numbers as companies in the enterprise IT sector that operate with longer-term contracts start to see this weakness come into their figures.
• I have looked at this sector as a safe place to hide from the weakness in consumer so far in 2023, but now the tables look to be turning with the consumer starting to stabilise and enterprise beginning to weaken.
• Cisco has seen a lot of progress in its strategy to diversify its revenue base into software as 44% of revenues now come from this sector but it is still not enough as these results plainly show.
• This is why Cisco is acquiring Splunk as its services will help diversify and smooth revenues once the acquisition has been completed.
• With FY 2024 EPS now likely to be something like $3.25, Cisco is on a 2024 forward PER of 14.6x making it one of the cheapest places to invest in the technology sector.
• However, I think I would rather look to consumer as enterprise now looks to be roughly where consumer was 12 months ago.
• Hence, in the short term, Cisco may prove to be a value trap and something best avoided for at least the next 6 months.
• I would steer clear of its peers as well for now.