Unlocking Profitability And Innovation With AI Infrastructure And Tactical Acquisitions

Key Takeaways

• Cisco's AI and security focus, including Splunk integration, drives significant product revenue growth and enhances profitability.
  
• Efforts in infrastructure modernization and operational efficiencies sustain growth and improve gross and operating margins.
  
• High reliance on federal orders, AI competition, and pricing pressures could challenge Cisco's revenue growth, margins, and profitability.

Catalysts

Designs, manufactures, and sells Internet Protocol based networking and other products related to the communications and information technology industry in the Americas, Europe, the Middle East, Africa, the Asia Pacific, Japan, and China.

• Cisco's focus on AI infrastructure is likely to drive significant growth, with expectations to exceed $1 billion in AI orders from webscale customers in this fiscal year. This is expected to boost product revenue significantly.
  
• The integration of Splunk into Cisco’s portfolio has enhanced security offerings, leading to increased customer adoption of new security products. These advancements should help improve revenue and margins from the security segment.
  
• Cisco's investment in modernizing infrastructure, particularly with its Nexus brand and Silicon One offerings, indicates continued growth in data center and enterprise market segments, contributing to sustained product revenue growth.
  
• Strong order growth from enterprise, service provider, and cloud segments, including significant contributions from AI networking, positions Cisco to realize increased revenue, especially in the back half of the fiscal year, thereby impacting earnings positively.
  
• The continued focus on operational efficiencies and cost reductions along with the favorable product mix is expected to sustain or enhance Cisco's gross and operating margins, which in turn boosts overall profitability.

Cisco Systems Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Cisco Systems's revenue will grow by 5.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from 17.7% today to 19.7% in 3 years time.
• Analysts expect earnings to reach $12.1 billion (and earnings per share of $3.2) by about November 2027, up from $9.4 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $14.0 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 23.5x on those 2027 earnings, down from 24.4x today. This future PE is greater than the current PE for the US Communications industry at 22.5x.
• Analysts expect the number of shares outstanding to decline by 1.71% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.69%, as per the Simply Wall St company report.

Cisco Systems Future Earnings Per Share Growth

Risks

• The slowdown in U.S. federal spending and the impact of the Fiscal Responsibility Act could delay potential deals and negatively affect revenue growth, as federal orders are significant for Cisco.
  
• Despite growth in core segments, the 23% decline in networking revenue due to previous elevated shipments indicates potential instability in revenue forecasting and challenges in consistent revenue growth moving forward.
  
• The high reliance on recurring revenue and order growth driven by acquisitions like Splunk highlights execution risk, especially if organic growth fails to meet expectations, impacting net margins and earnings.
  
• The competitive landscape in AI infrastructure, with companies like NVIDIA, poses a threat to Cisco's market position, potentially impacting future revenue and profitability from these high-growth areas.
  
• Continued pressure from unfavorable pricing trends, contributing between 1-2% as a headwind, affects the gross margin sustainability and could lead to reduced earnings if not balanced by cost improvements.

Valuation

• The analysts have a consensus price target of $61.78 for Cisco Systems based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $78.0, and the most bearish reporting a price target of just $50.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $61.7 billion, earnings will come to $12.1 billion, and it would be trading on a PE ratio of 23.5x, assuming you use a discount rate of 6.7%.
  
• Given the current share price of $57.46, the analyst's price target of $61.78 is 7.0% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.