J.P. Morgan Lowers Cisco (CSCO) to Underweight, Trims PT; Sees Lower Enterprise Spend, Macro Pressure

January 17, 2013 10:06 AM EST
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Price: $30.27 +0.56%

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J.P. Morgan downgraded Cisco Systems (Nasdaq: CSCO) from Neutral to Underweight today, cutting its price target from $20 down to $18.

Analyst Rod Hall says the biggest concern centers around sluggish enterprise spending amid a recent J.P. Morgan CIO Survey. He believes Cisco's risk/reward profile has shifted materially to the downside. He comments, "Despite refocusing on its core businesses, streamlining its operations, prioritizing margins and earnings over revenue growth and becoming more shareholder friendly (dividends, share repurchases), we believe investors’ positive sentiment and Cisco’s shares have run ahead of reality. We expect a difficult transition as Cisco aspires to be the #1 IT vendor and management places a greater emphasis on recurring revenue streams from software and services."

Macro headwinds will also be prevalent. Hall notes that there are indications of increased carrier spend in 2013.

Near-term, Hall believes that SDN will not materially impact earnings as Cisco is maintaining data center momentum with Nexus and UCS. But, he notes that that window is narrowing. The firm sees a data center switching market of $9.38 billion in CY14, without SDN. Including SDN, the firm sees a 27 percent drop to $6.83 billion. With assumptions that Cisco holds a 50 percent data center switching market share and 50 percent data center switching gross margin, that amounts to about 13 percent potential exposure to Cisco's fiscal 2014 EPS. He notes, "The optimal scenario for Cisco is to achieve 70% data center switching share and gross margin, but we believe this is highly unlikely given cut-throat competition."

There's also overall valuation. Cisco stock is up over 7 percent in 2013 and is approaching its 52-week high, putting valuation somewhere around 10 times two-year forward EPS expectations. Cisco traded at about 9.3 times that mark through its fiscal 2012 year.

Hall is cutting FY13 and FY14 revs outlook on Cisco to $48.23 billion and $50.5 billion, respectively. Gross margin will contract 40 basis points to 61.5 percent in FY14, versus Cisco's long-term GM goal of 61 percent to 62 percent. FY13 and FY14 EPS estimates are cut to $1.94 and $2.08, from $1.97 and $2.17, respectively.

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