Cisco Systems, Inc.

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 4/5

Cisco designs and sells a broad range of technologies that power the internet. They are integrating their product portfolios into networking, security, collaboration, applications, and the cloud. The company’s business is primarily driven by their ability to deliver secure, automated, and intelligent digital infrastructure and help their clients transform their businesses.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Cisco’s overall business is undergoing a significant transformation to better provide digital infrastructure for businesses in the modern era. They are doing that by integrating their products into the following categories: networking, security, collaboration, applications, and cloud.

Business Overview

Cisco Systems, Inc. (CSCO) is a technology giant, offering networking hardware, software, and services. The company’s core business revolves around building and maintaining the infrastructure that enables the Internet and private networks to function. They operate through three broad segments:

Americas: This geographical segment encompasses sales in the United States, Canada, and Latin America.
EMEA (Europe, Middle East, and Africa): This segment includes all sales in those three regions.
APAC (Asia-Pacific, China, and Japan): This segment is the Asia and Pacific Region.

Cisco is one of the world’s largest networking equipment providers, and their products are critical for enabling the internet as we know it.

Revenue Distribution

Cisco generates revenue from several sources, with product sales being the largest. The company is slowly transitioning to more subscription and service revenue, which are recurring and more predictable. Let’s look at the revenue segmentation:

Products: Includes revenues from selling network hardware equipment, security solutions, and collaboration devices.
Services: Includes revenue from providing ongoing software subscriptions, technical support, and professional services.

As of the latest report in Q1 2024, Product revenue was up 21.6% year over year and service revenue was 5.8% showing a shift from product to service sales which are more recurring. Cisco is also heavily investing into the cloud, so we should expect cloud related services to see a big uptick in growth.

Breaking down revenue by region (based on Q1 2024 results):

Americas: 60.8% of total revenue.
EMEA: 23.4% of total revenue.
APAC: 15.8% of total revenue.

Revenue from the Americas is larger and is a majority of revenue with good performance, the EMEA revenue has dipped a bit and the APAC revenue has been increasing slowly.

Trends in the Industry and Market Overview

The networking industry is undergoing a transformation driven by several key trends:

Cloud Adoption: Cloud computing is driving demand for more flexible, scalable, and secure networking solutions.
Remote Work: The rise of remote work has increased the need for secure and reliable remote access capabilities.
Security Threats: Increasing cyberattacks and ransomware pose constant security challenges for organizations.
AI and Automation: Businesses seek to implement AI in order to improve their efficiency.
5G and IoT: The deployment of 5G networks and internet-of-things devices is driving the need for more bandwidth and connectivity.

Cisco, being a tech company, has significant exposure to all of these emerging tech trends. These trends are providing great growth prospects for them as many of them directly related to infrastructure, which is exactly where they operate. However, it also increases risk because changes in the industry have a bigger impact on them.

Competitive Landscape

Cisco operates in a highly competitive market with a range of competitors:

Juniper Networks and Arista Networks: Compete in network infrastructure hardware. * Palo Alto Networks and Fortinet: Compete in network security solutions. * Microsoft and Amazon: Are major players in cloud computing. * VMware and Citrix: Compete in collaboration and communication space.

Cisco has been facing significant competition as the landscape shifts. This increases the probability that they will lose a larger percentage of their business and their customers to their rivals, which may affect their returns negatively.

What Makes Cisco Different

While Cisco faces tough competition, it also has several advantages that allow it to maintain its leading position:

Broad Product Portfolio: Cisco provides an extensive range of networking products, and a lot of the companies rely on them as they can fulfill all their infrastructure needs through one vendor.
Brand Recognition and Customer Relationships: Cisco has a widely recognized brand and long-lasting relationships with key partners.
Scale: Cisco has a wide supply network and infrastructure, which helps it to fulfill its operations on a huge scale.

Cisco is very well known in the industry, which makes a major difference as their established base of customers is very strong. It also allows the company to continue developing its network and products with its reputation to back them up.

Financials

Cisco’s finances are generally stable, but are also going through a transformation. Let’s dive into their latest earnings reports.

Q1 2024 Financial Results

Revenue: Total revenue for the first quarter of fiscal year 2024 was $14.7 billion, up 8% year over year.
Profitability: GAAP net income was $3.6 billion, up from $2.1 billion in the prior year. Non-GAAP net income was $4.0 billion, up from $3.6 billion in the prior year.
Operating Expenses: R&D expenses increased and Sales and marketing expenses increased as well. This shows that the company is trying to keep its innovative edge by spending more on research and sales.
Cash Flow: Cash from operations was $5.2 billion.
Guidance Q2 2024 revenue is expected to grow by 0.5%-2.5% YoY.

The results were positive for the company, showing an increasing trend. There was improvement in the metrics such as revenue, earnings, and cash flow. The company also expects a positive but low growth rate in the next quarter, so they are not facing major downturns.

Full Fiscal Year 2023 Results

Revenue: Total revenue was $57.0 billion, a 11% increase year over year.
Profitability: GAAP net income was $11.8 billion, up 4.6% YOY.
Cash Flow: Cash flow from operating activities was $15.7 billion.

The full year numbers were good as well, however, not as good as Q1 2024. There was double digit revenue growth and profit growth although not as good as expected. This is a recurring pattern that the company can produce good results in general but not in every single quarter.

Moat Analysis: 3 / 5

While Cisco possesses some valuable competitive advantages, they are not enough to award them a wide moat rating. The major reason is that their competitive landscape is constantly shifting as new technologies are introduced. They are facing competition from cloud giants and many upstarts, which means that their wide market share may decline.

Brand Reputation (Weak Moat): Cisco has a very well-known brand image in its niche which provides it some benefit in securing customers but the product itself does not create a sustainable advantage.
Installed Base (Narrow Moat): Many organizations are dependent on Cisco products due to integration or interoperability issues and the vast size of the networks, which makes switching tough. They also operate as a trusted entity with several long-lasting customers, which acts like a recurring revenue, however, it is difficult to see if these relationships are strong enough.
Scale Advantage (Narrow Moat): Cisco’s huge scale means that they have lower operational and distribution cost than their smaller counterparts. This makes them more competitive than smaller competitors and helps them to maintain market share.
Technology Innovation (Narrow Moat): Cisco has a good history of tech innovation, which allows them to stay ahead of the curve. They have R&D teams constantly working to improve their products and create new products that are crucial for businesses, however, it is not enough to give them a sustainable edge over their rivals.

The moat rating is 3/5, which means that the company has a decent moat but they are not invincible. Cisco is a pretty solid company with strong potential, but they will not hold the leading position without constant effort to improve their technology and operations.

Legitimate Risks to the Moat and Business Resilience

Despite their strengths, Cisco faces significant risks that could challenge their moat and resilience:

Intense Competition: The networking and tech sectors are filled with multiple competitors, which could put a dent in the company’s growth and margins.
Technological Disruption: New technologies can easily disrupt the company’s business, as it happened with the shift to the cloud and micro-chip industry.
Shift in Business Model: The shift to software subscription model may fail if their products aren’t as well received.
Global Macroeconomic Factors Global slowdown and trade restrictions can seriously affect their financial performance.
Supply Chain Disruption: Issues with raw materials and labor can hamper production, potentially leading to loss of earnings.

Cisco has been greatly impacted by several supply-chain issues and they are trying to reduce their lead times but the full impact is yet to be measured. They must carefully manage their inventories to overcome this challenge.

Understandability: 4 / 5

Cisco is a pretty understandable company. They have a clear business model with major revenue sources. Their financials and their overall operations are reasonably straightforward to understand. However, their complex internal system and complex product offerings make the overall understanding slightly difficult, leading to a 4/5 understandability rating.

Balance Sheet Health: 4 / 5

Cisco’s balance sheet is reasonably strong but some factors are bringing the score down.

Strong Liquidity: Cisco has $26.1 billion in cash and cash equivalents, which provides an excellent cushion to deal with business downturns or invest in new strategies.
Manageable Debt: Their long term debt is $8.1 billion, which they can easily service with their operational cashflows. Their debt-to-equity ratio is also quite low and within industry standard.
Inventory: Their inventories are at 7.9 billion, which is quite high. They need to improve their inventory management system and avoid build-ups of unnecessary inventory.
Acquisitions and Goodwill: Cisco has a history of acquiring other companies, which is fine if they are well integrated. But a significant portion of their total assets are goodwill and other intangibles (almost 20 billion).

Cisco has a strong financial position in general, with huge assets and not too much debt, however, their large amount of goodwill is a concern and should be taken care of in further assessment of the company. Also, they need to improve their management of inventories.