Cisco Systems Inc. came through with an impressive earnings beat for the second quarter and its sales guidance for the subsequent three months was well ahead of consensus, but the company’s outlook has much broader positive implications for the communications technology sector. The next capex cycle appears to have arrived.
Cisco said it saw “very strong balanced growth” in almost all major geographic and market segments. It also added more than 2,100 employees in the second quarter (roughly half through acquisitions) and plans to add another 2,000 to 3,000 in the next several quarters.
“Headcount growth is certainly a positive indication that Cisco expects a renewed spending cycle to be more than just a short-term inventory replenishment,” said National Bank Financial analyst Kris Thompson.
Cisco’s Switches and Routers segments finally posted year-over-year revenue growth as service providers and enterprise customers began spending on their communications networks again.
“It was only a matter of time until infrastructure spending accelerated,” the analyst told clients, highlighting hiring plans as an indication that customer spending will be sustained.
While Cisco appears to be capturing the leading edge of recovering tech spending, higher revenues are not coming for free given the employee additions in the next two to three quarters. This will result in modest margin contraction and cap earnings per share upside, according to J.P.Morgan analyst Steven J. O’Brien.
Citigroup’s Richard Gardner continues to see a return of 15 % to 20% on Cisco shares in the coming year as the company’s fundamentals rebound with the cyclical recovery in its top-line growth. However, those returns don’t place the stock among his top picks in IT Hardware space. Mr. Gardner see better leverage and top-line growth with Hewlett-Packard Co. in large cap enterprise hardware and Juniper Networks Inc. in networking.
Meanwhile, Mr. Thompson at National Bank said the networking giant’s upbeat outlook should be a positive for several names.
For example, he is cautiously optimistic that EXFO Electro-Optical Engineering Inc.’s recent backlog strength is the beginning of a sustainable carrier capex cycle. The analyst expects the stock will continue to move higher given the company’s focus on next-generation testing equipment, carriers moving to higher speed networks and the release of pent-up capex spending.
The take-away for Aastra Technologies Ltd. is not positive since Cisco’s weakest regions were concentrated in Europe. Aastra generates about half of its revenues in Germany, France and the Nordic region, and close to 25% in other European countries. Nonetheless, Mr. Thompson noted that the company has a solid free cash flow model and should double its dividend over the course of 2010.
So while picking winners will surely be more difficult this year than it was in 2010, most communications equipment vendors will benefit from a new carrier capex cycle.