Making a Pitch for the Bull Case
November 13, 2025 01:17 AM GMT
Meta A Marshall, Mary B Lenox, CPA
Contents
- Bottom Line
- Analysis
- Risk Reward - Cisco Systems Inc (CSCO.O)
- Financials
WHAT'S CHANGED?
From:To:Cisco Systems Inc (CSCO.O)
Reaction to earnings
UnchangedImpact to our thesis
Modest upsideFinancial results versus consensus
Modest revision higherDirection of next 12-month consensus EPS
Source: Company data, Morgan Stanley Research
CSCO's FQ1 posted slight upside, but the real surprise was on AI orders, which came in at $1.3bn in FQ1, with the company now expecting $3bn of AI rev in FY26. Remain OW as AI becoming more material, with sovereign opportunity still on the come, a setup which could support further rerating.
Key takeaways- AI orders of $1.3bn, with an expectation of ~$3bn of AI revenue this year, represented meaningful upside to our and buyside expectations.
- Despite concerns on campus switching cycle and Fed, both performed well, aligning with our checks.
- Gross margins headwinds from commodity pricing manageable, with gross margin guides staying as is.
- Security growth was disappointing, but explained in part by differences in how Splunk orders came in vs. expects on premise / cloud split.
- Remain OW given AI potential in scale-across and in sovereigns, both forward opportunities not priced into stock today.
| Stock Rating |
Overweight
| | Industry View | In-Line | | Price target | $82.00 | | Shr price, close (Nov 12, 2025) | $73.96 | | Mkt cap, curr (mm) | $294,545 | | 52-Week Range | $74.84-52.11 |
AI connecting Cisco to more growth opportunities. Our OW on Cisco had been based around a belief that growth opportunities between campus upgrades, Splunk and AI were enough to help Cisco generate double digit earnings growth, which overall should help the company close the ~5x turn gap it has with the S&P. Two of three of those drivers are performing better than expected currently, with AI growth potential far greater than expected. While we had entered the quarter relatively muted, we did note that AI orders greater than $1bn would be a positive catalyst, which Cisco outperformed with $1.3bn of orders. With the company now expecting ~$3bn of revenue in FY26 from AI, Cisco’s AI business has gone from ~2% of the company to almost 5% in a couple of years, becoming a more meaningful contributor to growth. Combined with a healthy campus upgrade cycle, this lays the groundwork for rerating potential, particularly if sovereign opportunity becomes more sizeable over the next year, keeping us OW.
What we liked:
- AI demand outperformed, with more to come. Cisco's AI orders were $1.3bn in the quarter, up from $800mm last quarter, with the company believing they will now book $3bn of cloud AI revenue in FY26 (up from ~$1bn in FY25). This strength is on the back of 4 new engagements, one with each of the hyperscalers, and is fairly evenly split between optics and switching. We would note the company also spoke to another $2bn of pipeline for revenue from neo clouds / sovereigns / enterprise AI use cases. Given we think scale across will be a bigger market over the next couple of years, we see continued growth potential for Cisco with their Acacia / Luxtera / Silicon One portfolios.
- Early campus refresh traction. Cisco noted that in FQ1 the company saw accelerated order growth across their campus portfolio (switching, routing, wireless, IoT). This had been a trend we picked up in our checks and an opportunity we highlighted in a deep dive earlier this year. However, given uncertainty with macro / tariffs, we were uncertain whether we would see strength here until early next year.
- Gross margins remained resilient despite commodity headwinds. Cisco's gross margins came in at 68.1% vs. our expectation of 68% in FQ1. This was despite Splunk revenue underperforming expectations during the quarter (as a result of on-premise / cloud mix). Additionally, this is a level the company believes they can maintain despite meaningful recent increases in DRAM pricing. While not calling out inventory balances, the company did note they have memory commitments to meet outlook, a positive given constraints in the market currently.
What we are watching:
- Security portfolio underwhelmed, though some of that due to business model transitions. Cisco's security business was down 2% Y/Y, worse than our expectation of 4.5% Y/Y growth and meaningfully below 15-17% targets the company has laid out. The company noted that while ongoing product transition is a headwind on the core business (new products about 1/3rd of the business, growing double digits), the difference in performance vs. expectations was largely attributable to Splunk revenue coming in differently than expected. The company had expected about 50/50 split between on-premise / cloud, with actual revenue coming in 1/3rd on-premise / 2/3rd cloud, a headwind to performance. To highlight this, Splunk ARR and product RPO grew double digits in the quarter (added ~250 new customers). We continue to monitor the security business given profitability and key to pulling through other networking business, but were encouraged by some of the Splunk detail given vs results.
- Outlook implies core growth (ex-AI) below longer term growth targets. Cisco laid out a 4-6% revenue growth CAGR target at their Analyst Day in 2024. While the AI story is running well ahead of expectations, and providing a significant multi-year growth tailwind for the company, backing out expected AI growth from the ~8% revenue guide for FY26 gets you to sub 4%. Part of this headwind is the Splunk revenue transition highlighted above, which gives us more confidence in the core business.
- Capital allocation still opting for share repurchases vs. debt repayment. Cisco generated ~$3.2bn FCF in FQ1. While the company is operating at <1x net debt / EBITDA, the company is choosing to use cash for share repurchases ($2.3bn in the quarter) vs. debt repayment in the near term. The company notes they would like to maintain flexibility on the balance sheet, which current levels certainly afford.
Networking strength offset security weakness.
CSCO reported FQ1 non-GAAP revenue / EPS of $14.9B/ $1.00 ahead of our expectations of $14.7B/$0.98. Product orders were up 13% Y/Y, with Service Provider/Cloud orders up 45% Y/Y. Non-GAAP gross margins were 68.1% (vs. MSe of 68.0%), which benefitted from less impact from tariffs. There were $1.3bn AI orders in the quarter from hyperscalers. Upside in the quarter was driven by networking that came in at $7,768mm vs MSe of $7,459mm, benefitting from campus refresh. This was somewhat offset by security underperformance of $1,980mm (vs. MSe of $2,107mm). Top-line drove stronger EPS of $1.00 (vs. MSe of $0.98). We increase FY26 to reflect strong networking demand, particularly the campus refresh. Our revised FQ2'26 / FY25 non-GAAP revenue / EPS estimates are now $15.1bn / $1.01 and $60.6n / $4.09 vs. $14.8bn / $1.00 and $59.5bn / $4.02 previously.
Remain OW, $82 PT from $77. We rollforward our PT to FY27 estimates. Our $82 base case represents 19x a ~$4.32 FY27 EPS (from 19x a ~$4 FY26 EPS). Our multiple of 19x is based on the upper end of the traditional range. Our $56 (from $54) bear case reflects 14x $4 EPS (from 14x $3.8 FY26 EPS). The 14x multiple is closer to trading averages over the last 10 years. Our $100 (from $92 FY26 EPS) bull case assumes bull case FY27 EPS of $4.50 (from $4.2 FY26 EPS). The 22x multiple is closer to the historical 10-year peak multiple. We believe CSCO could trade closer to the bull case with the Cat 9k refresh cycle or if AI cloud business were to become more meaningful to growth of the entire business. Risks to our PT include changes in tariff and macro weakness.
Morgan Stanley
11/13/2025 |
