Here’s How I’d Trade Cisco Without Risking a Fortune

November 17th. It was a Wednesday afternoon. Cisco (CSCO) posted fiscal first quarter financial results and forward looking guidance that failed to impress. The stock sold off hard overnight and closed at $53.63, -5.51% after trading more than two dollars lower than that the next day. The stock has run more than 16% over the five weeks plus since. This is that story.

Earnings were okay. Cisco put adjusted EPS of $0.82 and GAAP EPS of $0.70 to the tape. Both numbers were good for beats of two pennies. Revenue of $12.9B fell short of Wall Street’s expectations, but was enough for year over year growth of 8.1%. CEO Chuck Robbins sounded optimistic… “Cisco’s technology sits at the heart of the accelerated digital transformation happening today. Our breakthrough innovation, strong demand, and the success of our business transformation positions us well for another year of growth in fiscal 2022.”

The firm’s guidance was however, at best… pedestrian in nature. Cisco guided the current quarter toward sales growth of 4.5% to 6.5%, well below the 7.4% or so that most of Wall Street had in mind, with adjusted EPS of $0.80 to $0.82. Consensus view there was for $0.82. For the full year, Cisco projects revenue growth of 5% to 7%, and adjusted EPS of $3.38 to $3.45 versus expectations centered around $3.43.

Surging Interest

On December 8th, CEO Chuck Robbins presented at the Barclays Global Technology, Media and Telecommunications Conference. He spoke of a web scale business that grew 200%, of Remaining Performance Obligation growing at 18% to more than $30B… which is a leading indicator for primarily software related revenue. Robbins also spoke of transitioning to a recurring revenue subscription model and the transition to 5G. Investors started listening.

On December 14th, Evercore ISI named Cisco, along with Apple (AAPL) as the firm’s leading picks for IT hardware and networking for 2022. Evercore sees Cisco as its leading enterprise recovery pick with a chance to re-rate in 2022 thanks to better macro “tailwinds” and product cycles across switching and “campus.”

Then there’s the Metaverse, or Omniverse, or whatever you prefer to call it. This next revolution in technology will require accelerating computing, Hyperscale data centers will likely be the physical plumbing of this semi-virtual to virtual world. Beyond the physical data center will be reliable, sustainable fixed broadband and seamless 5G, and then eventually 6G coverage.

Who benefits here? Cisco is still the largest supplier of computer networking gear even if that lead has dwindled and even if such gear at one point, appeared to be less of a driver of future valuations. Competing with Cisco would be the likes of Juniper Networks (JNPR) and Arista Networks (ANET) . Cisco, don’t forget, has that marketing partnership with International Business Machines (IBM) to pursue edge computing deployments. We’ll see what comes of that.

Fundamentals

The balance sheet is fine. Yes, the firm’s cash balance did drop over the three months ending with Halloween, but a little detective work reveals that just about the entire re-allocation of cash assets went into short-term investments, inventories, and the paying down of both shorter-term and long-term debt. Current assets dwarf current liabilities and total assets dwarf total liabilities less equity. The current ratio is closer to two than it is to one.

Beyond that, margins have been in decline as have both levered and unlevered free cash flow. This is probably the impetus to transition the firm to the recurring revenue model. On the bright side, net capital expenditure has been in decline as well. The firm does pay shareholders $1.48 per share annually, good for a yield of 2.38%, while still trading at 18 times. Basically, this is a “tech” value stock.

The Chart

Just look at that explosive over since earnings. Hoo Doggy. Would I like to be long this name? Sure. Did I have the foresight to be in this name? Of course not. I won’t tell you what to do, but for me, the RSI, Full stochastics Oscillator and daily MACD are all screaming… “Don’t do it Sarge, you can find a smarter way to get there.”

So, I listen to my three friendly indicators. You guys are right. The stock is technically overbought. Let’s do some thinking. Ureka! I’ve got it. We do have a cup with handle pattern that bears a $59 pivot. That, using my method, would place the initial target up around $72.

One might think that CSCO will at some point experience some profit taking and could test the 21 day EMA from above. What I could do, without risking a fortune is this… (in minimal lots)… earnings are due around middle to late February…

– Purchase one CSCO February 18th $65 call for roughly $1.40.

– Sell one CSCO February 18th $60 put for about $1.40.

Notes: The options trades are a wash. Trader isn’t spending a dime up front. Stock runs? Trader has the right to purchase 100 shares at $60 at expiration. Stock takes a dive? The trader could be on the hook at $60 by mid-February, which would be a heck of a lot better than being on the hook at the last sale in that situation. If that does happen, the trader could always sell a call at that time to further reduce net basis… plus there’s a real dividend.

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