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Technology Stocks : Cisco Systems, Inc. (CSCO) -- Ignore unavailable to you. Want to Upgrade?

To: Amy J who wrote (67099)	2/17/2005 10:44:42 AM
From: William F. Wager, Jr.	Read Replies (1) \| Respond to of 77400

Cisco shows early signs of a rebound... The stock is likely to hang around its current level for the near term. But the company's push into new products should boost sales. And that will push the stock higher. By Robert Walberg All of a sudden, Cisco Systems has become the Rodney Dangerfield of the technology world. Despite delivering solid double-digit sales and earnings growth in each of the last two quarters, the stock can't get no respect from investors. Cisco (CSCO, news, msgs) has toiled near its 52-week low for the past six months -- and that's no laughing matter. Fortunately, CEO John Chambers is working on a new act that should put smiles back on investors' faces. But before we look ahead, let's take a quick look at Cisco's recent past and why it has left analysts and investors in a sour mood. One factor depressing investors and the stock has been the gradual decline in the company's gross profit margins. The slight drop in gross margins during the company's fiscal second quarter, which ended Jan. 29, was due almost exclusively to a drop in services margins related to new hiring. Product margins held steady. But pricing pressures on large contracts, the steady rise in sales of low-margin Linksys products -- wireless devices for consumers -- and a more competitive router landscape suggest that product margins will come under pressure for the next couple of years. In fact, the Street expects gross margins to dip by about two percentage points in fiscal 2005, which ends in July, and by another percentage point in fiscal 2006. Banks and insurers check your credit. So should you. Declining margins aren't the only concern investors have with Cisco. The company's second-quarter earnings report showed a marked slowdown in domestic sales. Given that the Americas region still accounts for 45% of total sales, the drop-off was alarming. Cisco cited a slowdown in government orders for the weakness. Unfortunately, government orders aren't expected to pick up any time soon, and business demand has been inconsistent in recent quarters. These uncertainties about demand cloud the revenue picture over the near term and add to the risk of holding the stock. Depressing growth rates The Chinese market is also cause for concern. Management has noted that competition in China is intensifying. China's attempt to slow its pace of economic growth won't help matters much over the near term, either. The country doesn't represent a huge percentage of overall sales. But any slowdown there will depress growth rates, since Cisco sees the nation as a major growth market. Finally, like many of its big-tech brethren, Cisco is suffering from the maturation of its core router and switching businesses. In the last quarter, switching sales (about 40% of total sales) fell 7% from the previous quarter. This decline, caused in part by weak government sales, followed three relatively strong quarters. As these core markets mature, growth inevitably slows and margins tend to contract. This fact, more than anything, explains why the stock no longer commands the type of premium multiple that Cisco investors came to expect during the last decade. While all of these issues are apt to keep the stock from breaking above stubborn resistance around $20 a share over the next few months, there's reason for long-term optimism. Cisco's attempts to transition its business continue to meet with success. Just look at the impressive sales growth in its Advanced Technologies segment. The unit, which includes security, storage, IP telephony and Linksys, posted 41% year-over-year sales growth in the most-recent quarter. Equally as impressive was the fact that every product group posted double-digit growth. Advanced Technologies now represents 19% of total sales. That's not material enough to completely offset the slowdown in its core business, but it's certainly encouraging enough to support the stock at -- or very near -- current levels. If Cisco can continue to grow this segment of its business at 15% to 20% a year for the foreseeable future -- and there's no reason to think that it won't -- then the outlook for the stock brightens considerably. Defending its turf The gains in new product areas aren't the only reason for investors to warm to Cisco's stock at current levels. There's also the incredible strength of its balance sheet, a rare commodity these days and one often overlooked by growth investors. With about $5.7 billion, or more than 86 cents a share, in cash and cash equivalents and with its ability to generate impressive cash flow, the company is well-positioned to defend its turf and continue seeking out new, fast-growth markets. Then there's the valuation. At 3.5 times trailing 12-month sales and 20 times estimated fiscal 2005 earnings, the stock might not seem cheap. But Cisco is trading at a discount to its peers, not to mention its historic norms. Given its leadership position in the industry, solid balance sheet, impressive growth in new markets and relatively strong return on equity (21%), such a discount should prove temporary. In light of management's cautionary guidance for the fiscal third quarter and the normal seasonal slowdown, the stock is apt to languish near current levels for another couple of months. But as business begins to pick up in its fiscal fourth quarter and beyond, Cisco bulls will get the last laugh. Assuming modest expansion in the price-to-earnings multiple to 24, the stock will eventually blow through resistance in the $20-to-$21 area on its way back above $24. A move to this ceiling would represent a 34% jump, and that should certainly be good enough to make Cisco investors smile once again. At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column. moneycentral.msn.com