Cisco Significantly Undervalued
Jan. 13, 2015 10:58 AM ET  |  About: Cisco Systems, Inc. (CSCO)
Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in CSCO over the next 72 hours. (More...)
Summary

2014 ended well for Cisco shares.
Positive demand trends for Nexus 9K.
SDN concerns over-exaggerated.
My Levered Returns model illustrates a fair value estimate of approximately $38 – a 35% premium to CSCO’s January 12th closing price.
Overview

Cisco (NASDAQ:CSCO) shares performed well in 2014, growing 21%, despite a year-on-year decline in company revenues. Add the 2.8% dividend yield on top of that, which acts as a sweetener. There may in fact be further upsides for 2015, which may come about by way of higher gross margins as well as subsiding SDN concerns which have acted as a drag on the stock price for some time. In addition, the rising inter-cloud division may add further value going forward. In view of these factors, I have used my Levered Returns model to calculate the fair value of Cisco's stock and found that it is trading at a significant discount as of its January 12th closing price.

Growing Gross Margins to Impact Multiples

For Cisco, gross margins have an impact on multiples, and this is what has resulted in the stock price re-rating over the course of 2014. Management's effort to keep gross margins in the 61-62% range has helped grow earnings that has resulted in multiple expansion (PE multiple from a recent low of 8x to 12x). Amid a competitive environment, Cisco is re-thinking its products and streamlining the supply chain which has helped improve margins. Finally, a higher software component in the revenue mix may enable the company to hold the current gross margin level of 62-63% for the foreseeable future.