Sue offered four primary reason for the more bullish stance:
- "Firming visibility to our forward estimates."
- "Gross margin stabilization."
- "Improving execution."
- "Favorable risk/reward."
Sue raised his EPS estimate for calendar 2014 to $2.20 a share, a bit ahead of consensus at $2.16. He adds that in his best case scenario, calendar 2014 profits could reach $2.45 a share, with revenues up 8%-9%, fiscal year. (Although he thinks 5%-7% top line growth is probably more realistic.)
"Many of the negative issues related to Cisco have subsided," Sue writes. "Cisco’s core markets are no longer under attack from Huawei, HP and Juniper and Cisco’s market shares have rebounded and stabilized. Cisco has also improved its sales execution and refocused its engineering talent. With [operating margins] at ~28%, we believe another $1 billion can be further reduced from Cisco’s cost structure which gives us added visibility to our forward earnings estimates. Macro swings are inevitable yet earnings are likely to be protected for Cisco."
Sue also thinks gross margins can improve as the company focuses on growing its software business. "Longer term we believe higher software contributions, supply chain efficiencies and de-emphasis on margin drag products may enable GMs to approach 64%," from a recent 62.7%. He's forecasting 62.2% this year; note that Cisco’s own target remains 61%-62%.
Also noteworthy is Sue's view that the threat to Cisco's core routing business from software-defined networks is likely to dissipate.
"The threats of SDN displacing switching and routing equipment are subsiding with the possible impact likely 5-7 years from now and the scope narrowed to specialized data center applications," he writes/ Meanwhile, Cisco has made a number of SDN-related acquisitions "to protect its positioning with major data center customers."
Not least, Sue notes that Cisco generates about $10 billion a year in free cash flow annually - a level he thinks will increase over time. He thinks the company, which has $45 billion in cash - mostly overseas, though - will increase its dividend, which now offeres a yield of 2.8%.
Cisco this morning is up 22 cents, or 1.1%, to $20.56.
Disclosure: My wife is a Cisco employee.
