Cisco Systems (NASDAQ: CSCO) is like the wisdom of a financial sage handed down through the generations. For conservative income investors, the company is a fortress of stability. It’s the world’s largest networking company, trading at a mere 13 times this year’s adjusted earnings, and offering a juicy forward yield of 3.3%.

While underperforming against a robust S&P 500 that surged more than 20% over the last 12 months, Cisco still stands as an icon of fiscal prudence and dependability. But is it truly a diamond in the rough, or is it slipping into a stagnant quagmire with no real hope of revival? Let’s dive in to find out.

Image source: Getty Images.

The Rise and Stall of Cisco

Cisco’s revenue experienced a 5% dip in fiscal 2020 due to pandemic disruptions in the sales of networking hardware and software. This trend persisted into fiscal 2021, where revenue only eked out a 1% gain, and again into fiscal 2022 with a modest 3% increase as supply chain constraints throttled the sales of routers, switches, and wireless networking devices.

However, a ray of hope pierced through the gloom in fiscal 2023, with a remarkable 11% revenue jump as Cisco overcame its supply chain issues and met the pent-up market demand for major network upgrades. This recovery seemed to suggest that the company could surpass its long-term growth targets of 5%-7% CAGR for revenue and adjusted earnings per share (EPS) from fiscal 2021 to fiscal 2025.

Regrettably, Cisco’s growth momentum appeared to hit a pothole over the last two quarters, with both revenue and EPS heading south in the second quarter of fiscal 2024.

Data source: Cisco. YOY = year over year.

Cisco attributes this slowdown to an unexpected surge in customer orders when its supply chain constraints relaxed in fiscal 2023. Upon receiving these orders, customers deployed their equipment at a slower rate due to macroeconomic headwinds, trimming their spending on substantial networking upgrades. Consequently, the market demand for new networking devices experienced a precipitous decline.

As if that were not enough, Cisco anticipates an additional 16%-17% year-over-year decline in revenue for the third quarter, with a full-year drop of 8%-10%. Nevertheless, its forthcoming acquisition of Splunk might serve as a counterbalance, enhancing its minor observability software business (comprising a mere 1% of its revenue in the first half of fiscal 2024) by the time the deal concludes in the first half of fiscal 2025.

Analysts project a 2% increase in Cisco’s revenue to $53 billion in fiscal 2025, reflecting a CAGR of less than 2% from fiscal 2021 and lagging far behind its long-term growth objective of 5%-7%.

Margin Expansion Amidst the Turmoil

Although Cisco’s revenue growth hit a plateau, its adjusted gross and operating margins continued to expand year-over-year in the initial half of fiscal 2024.

Data source: Cisco.

Enhanced gross margins, attributed to lower freight costs, component costs, and a favorable product mix, offset the pricing pressure from delayed deployments. Moreover, Cisco foresees its acquisition of Splunk resulting in a further augmentation of its gross margins. It further bolstered its operating margins through assertive cost reduction measures, with plans for an additional 5% workforce reduction this year.

Unfortunately, despite its expanding margins, Cisco still anticipates a 14%-16% year-over-year dip in adjusted EPS for the third quarter, and a 4%-5% decline for the full year due to the overwhelming impact of diminishing sales. Market analysts predict a 4% surge in its adjusted EPS in fiscal 2025, indicating a CAGR of 4.5% that falls short of its long-term growth goal of 5%-7%.

Value Stock or Value Trap?

While most of Cisco’s current issues appear cyclical, it faces fierce competition from networking behemoths such as Arista Networks and Hewlett Packard Enterprise, the latter recently announcing its acquisition of Juniper Networks. This formidable competition may stifle Cisco’s growth, compress its margins, and prompt further acquisitions to widen its competitive moat.

Consquently, we advise investors not to expect an overnight rebound for Cisco following its recent downslide. However, given its low valuation and robust yield, it seems poised to weather the storm without tumbling further.

I would hesitate to label Cisco a value trap. The company’s core operations remain stable, its dividends are easily sustainable with a mere 47% payout ratio, and it is set to stay resiliently profitable in the foreseeable future. Thus, it masquerades more as a decent value stock, offering a safe haven for investment cash while furnishing steady dividends.

Yet, Cisco’s investors should brace themselves for a while longer, with the company expected to continue trailing the market until its revenue and earnings regain their foothold. In light of this, many income investors may gravitate towards CDs or T-bills, sporting superior yields to most blue-chip dividend stocks in this high-interest-rate environment.

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Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Arista Networks, Cisco Systems, and Splunk. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.