Cisco Profitability Improves, but Growth Outlook Muted

Cisco (CSCO) finished its fiscal 2016 on a sour note, posting a 2% year-over-year revenue decline as a result of softness in its routing segment and stagnant data center segment. On the positive side, Cisco’s switching segment returned to growth, while gross margins continued to expand despite pricing pressures. The company announced a restructuring plan that will eliminate 5,500 positions (7% of its global workforce) in low-growth areas, but we expect investments in strategic growth areas such as security, cloud, the Internet of Things, and collaboration. We continue to temper our expectations for top-line growth as Cisco navigates the industry’s transition to the cloud- and software-defined world, but we think that recent improvements in profitability will endure. We expect to maintain our $27 fair value estimate for this narrow-moat company.

Total revenue for the quarter was $12.6 billion, down 2% year over year, but up 5% sequentially. The service provider segment remains a challenge for the company, as routing revenue declined 6% year over year and 1% sequentially. On the bright side, switching and wireless segments returned to growth this quarter (up 2% and 5%, respectively, year over year) while Cisco’s collaboration segment remained on a strong growth trajectory, up 6% year over year and 7.5% sequentially. We like Cisco’s strategy of tightly integrating its burgeoning portfolio of security products with switches and routers, but we wonder whether this will be enough to prevent an eventual revenue decline in both segments. We are also concerned about the company’s datacenter segment, which ceased to grow after first-quarter 2016. The datacenter market appears to be pivoting strongly toward hyperconverged solutions, which renders Cisco’s traditional blade architecture less attractive, while the company was late with its hyperconvereged HyperFlex offering, as well as pure cloud infrastructure-as-a-service architectures.

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