Among tech giants, Cisco Systems (NASDAQ:) isn't arousing much excitement. The world's largest router and switch manufacturer dominates a cyclical market, focusing on low-margin hardware products.
But this is going to change drastically in the next four years. The Silicon Valley strongman is transformed into a provider of network services delivered over the Internet and a seller of software.
Subscription revenues will be 50% of Cisco's total by fiscal year 2025, the company said in a presentation to analysts on Wednesday. As part of this push, the company is revamping its existing product categories to better align them with customer needs.
In November, Cisco begins to break out into five categories: secure flexible networks; hybrid work; end-to-end security; internet for the future; and optimized application experiences. As the company pursues this shift, annual sales are forecast to grow 5-7% over the next four fiscal years.
The higher margin company will also improve earnings, with a compound annual growth rate for adjusted earnings of approximately 4% to 7% per year and a mid-2025 target of $4.07 per share.
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Judging by Cisco's stock performance, it's clear that investors appreciate Chief Executive Chuck Robbins' strategy to drive growth. The stock is up about 30% this year, roughly double the returns tech-heavy produced over the same period. The stock closed at $57.33 on Thursday.
Analysts turn bullish
Under Robbins, Cisco has made a series of acquisitions to build a software and services company. In 2019, it acquired Acacia Communications for approximately $2.6 billion, providing chips and machines that help convert optical signals into electronic data.
These growth initiatives, coupled with the company's dominant position in the Americas, where it generates the majority of its revenue, has positioned the company to outperform as macroeconomic risks diminish.
Some analysts have turned bullish after the company's latest update and have upgraded the stock to their buy list. Credit Suisse analyst Sami Badri has upgraded Cisco to outperform neutral, saying the company's transition could push stocks 30% higher than current levels.
In a note, Credit Suisse stated:
"We continue to find supporting evidence suggesting that corporate and public sector customers (~55% of total revenue) are just beginning their new wave of product orders and deployments, indicating an acceleration in activity."
Credit Suisse raised its price target for Cisco from $56 to $74 per share.
Cisco's new performance metrics focus on increasing Cisco's stock price, as recurring software sales revenues are generally valued more highly by the market than one-time software sales or one-time sales of switches and sensors.
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Meanwhile, JMP Securities said in its note:
"Management also sees the intertwined trends toward hybrid/remote working and the shift to hybrid, multi-cloud architectures as a favorable industry tailwind that positions the company to gain market share."
In addition to growth, Cisco is also a reliable dividend payer. While Cisco is not yet considered an aristocrat, given that it has only been paying dividends for 12 years, Cisco has nevertheless increased its payout every year, making it an attractive option for those looking for growing income.
With a current annual return of approximately 2.56%, investors receive a quarterly payout of $0.37 per share. With a manageable payout ratio of 58%, there is more room for dividend increases going forward.
Bottom Line
Cisco's outlook is improving as the company accelerates its transition to a high-margin services business. That shift has made its stock attractive to both growth and income-oriented investors.
