A tough telecoms stock to weather the storms

published 31 May 2012

Opportunities abound in telecoms infrastructure, particularly for Cisco. The industry is well placed as next-generation wireless and fixed line networks are rolled-out to satisfy data-hungry devices such as tablets and smartphones.

The $90bn networking giant boasts a 64% market share in internet protocol TV (IPTV), 53% in optical routers, 69% in switches, 44% in storage area networks, 53% in wireless local area networks (LAN) and 38% in web conferencing. This is all backed up by 8,000 patents, 20,000 engineers and an annual R&D budget worth $5.8bn.

In short, Cisco is an expert on everything internet-related, as evidenced by its gross margins of 62%. And in a world of clouds, video, social media, data warehousing and mobile device proliferation, the role of the network has never been greater.

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Another bright spot is the forthcoming upgrade cycle to 100-gigabit technology. With data traffic growing 30%-40% a year until 2015, carriers are being forced to shift to higher bandwidth switches to keep up with exploding volumes. Cisco is also seeing the benefits of last year's 6,500 headcount reduction and the mothballing of its Flip video camera arm.

Cisco (Nasdaq: CSCO), rated a BUY by Evercore Partners

For the year ending July, Wall Street is predicting turnover and underlying earnings per share (EPS) of $46bn and $1.84 respectively, rising to $48bn and $1.92 a year later. That puts the firm on a price/earnings (p/e) ratio of less than ten, with a 1.9% yield. The balance sheet has net cash of $29.8bn that's plenty of ammunition for future acquisitions. So I rate the stock on eight times 2012's earnings before interest, tax and amortisation (EBITA) multiple. Adjusting for cash generates an intrinsic worth of $23 per share.

Cisco is exposed to risks such as price deflation, competition, foreign currency movements and component supply issues. Another concern is the recent soft patch caused by the uncertainty generated from the European debt crisis and the forthcoming US presidential elections. Last month CEO John Chambers warned that as a result nervous business customers are unwilling to spend on internet-related kit albeit they should still "spend more in the second half".

Yet with a huge installed base providing a rich seam of recurring revenues and cross-selling opportunities Cisco should ride out today's headwinds. Evercore have a price target of $26.

Rating: BUY at $16.50

Paul Hill also writes a weekly sharetipping newsletter, Precision Guided Investments. See www.moneyweek.com/PGI or phone 020-7633 3634 for more.

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.