An acquaintance recently asked me about the state of the markets. I said that until the banks started lending again and three-month Libor (the interest rate banks charge each other for three-month loans) dropped back to more normal levels, then deleveraging would continue, and we’d be lucky to see any prolonged recovery in stocks. But I added that, depending on one’s own risk appetite and time horizons, the indiscriminate selling meant there were now some outstanding bargains.
Cisco Systems (Nasdaq:CSCO), rated a BUY by Lazard Capital
My main selection criteria are that a company should have positive cashflow, a sound balance sheet, and strong market positions. It should also generate organic growth and be trading at attractive levels. Ticking all these boxes is usually a challenge, yet in today’s panic-driven climate it is surprisingly common. One such stock is Cisco Systems. This internet equipment and software giant sells about 50% of all optical routers and 80% of switches supplied to companies globally. Turnover has risen on average by 16.5% a year over the past five years, hitting $39.5bn for the year ending July 2008. Roughly 65% of this was to enterprise/ government customers, with the rest to telephone operators (such as AT&T).
Growth is likely to slow this year with revenues rising by 8% in the first half. But over the economic cycle, Cisco chief executive John Chambers believes the company can deliver 12%-17% annual rates, driven by exciting initiatives in video ($20bn sector), virtualisation ($85bn), collaboration ($34bn) and services. One of its hottest products is its TelePresence video-conferencing system, which uses 3D-surround-sound and life-size high-definition images to recreate the feeling of meetings without any of the problems of jerky pictures and poor audio quality. With cost cutting (and ‘green’ issues) high on the agenda, senior executives are realising that this technology beats jumping on an aircraft.
Also, Chambers believes technology will play an important role over the next few years in improving productivity, just as the US saw in the mid-1990s. This time, the huge efficiency gains will come from using new Web 2.0 and collaboration tools, rather than from ERP systems (software that helps businesses to organise their processes).
Cisco had a cash pile of around $20bn at the end of July and generated $11.5bn in operating cashflow last year. This gives the firm plenty of ammunition for strategic acquisitions, and allows it to increase market share, especially where customers seek vendor financing as part of large-scale equipment deals. Wall Street expects current-year sales and underlying earnings per share (EPS) of $42.8bn and $1.65 respectively, rising to $47.6bn and $1.87 in 2009/10. That puts the stock on frugal multiples of less than 11 times earnings and 9.2 times cashflow. There are risks, such as more aggressive competition from the likes of Juniper and China’s Huawei Technologies. A stronger dollar and tighter corporate IT budgets are also challenges. But there is no doubt that Cisco possesses the necessary arsenal to survive even the harshest of recessions, and looks attractively priced for the patient investor. The next quarterly results are out on 5 November.
Recommendation: BUY at $17.55
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.