Trade Ideas August 12, 2020

Cisco Systems (CSCO) FQ4 Earnings Preview / Trade Ideas

by Dan

Cisco Systems (CSCO) will report its fiscal Q4 earnings today after the close. The options market is implying about a 5.5% tomorrow, which is below the average one-day post-earnings move over the last four quarters of about 6.4%.

Shares of CSCO down about 1% on the year, trading within a range between $44 and $48 since it last reported in mid-May. With the stock near $47.50, the implied move of about $2.65 in either direction would have the stock either threatening near-term support near $45 or banging up against prior technical resistance from late 2019/early 2020 near $50:

 

Wall Street analysts are fairly mixed on the stock with 14 Buyts, 13 Holds, and 2 Sell ratings with an average 12-month price target of about $49.50, or about 5% higher than current levels.

Shares of CSCO trade about 15x expected fiscal 2021 eps, which analysts see has growing 1% year over year on flattish revenue growth. The company has a stellar balance sheet with $28.5 billion in cash (nearly $9 billion net of debt) which is about 15% of its $200 billion market cap.

Sam Bardi from Credit Suisse who rates the stock a neutral with a 12-month price target of $41 highlights in a note to clients 5 areas of investor focus:

(1) Investors continue to focus on a potential SP inflection driven by the new product that CSCO introduced in December 2019, including the Series 8,000 Routing platform, which we note is not contributing to SP strength yet (undergoing extensive SP testing, like all new routing systems).

(2) As Video Conferencing popularity surges as a means of in-person meetings to execute business, WebEx is expected to benefit. However, given the fierce competition in collaborative meeting services, we are in a wait-and-see mode for WebEx traction.

(3) Based on CSCO FCF minus capital allocation (dividends + buybacks), we estimate CSCO has $5.0B in FY20 and has $4.7B in FY21, a considerable amount to utilize for M&A. Investors now focus on the next take-outs following the ThousandEyes acquisition.

(4) As CSCO businesses tied to campus networks (WLAN / Campus Switching) continue to see challenges in the next quarter until lockdown restrictions are eased, investors are focused on how margins may be impacted. Once factoring the aforementioned dynamics,

(5) we believe valuing CSCO at a 13.5x multiple is fair given where it traded in CY19, its recurring revenue mix, and the key battleground (opportunities/threats) areas

The mention of WebEx is interesting as it will become fairly clear that Zoom (ZM) is eating their lunch and I would expect the company to deploy that balance sheet to make an acquisition n the not so distant future to offset the headwinds in their legacy networking businesses that may face some near-term headwinds from a weak service provider and enterprise spending environment as they look to push further into recurring software revenues.

My Take into the Print:

I am positively predisposed to the name and think given the valuation, benefit of the weak dollar, strong balance sheet, and some of the technology trends in a pandemic environment, despite possible pickets of weak spending should be ok for CSCO. I would also add that the rotation out of growth into cyclical value should also benefit CSCO if the stock market’s rally is going to continue to broaden out.

I think it is fair to say that expectations are not high given the stock’s recent consolidation and its massive underperformance to the Nasdaq. Obviously a miss and guide lower and the stock is easily down inline with the implied move and likely more towards 10%.

 

So what’s the trade?

If I were inclined to play for a beat and raise and a gap above prior resistance near $50 I might allow for more than a day for this play out and look to next’s Friday’s regular expiration:

Bullish Trade Idea: CSCO ($47.50) Buy Aug 47.50 call for $1.35

Break-even on Aug expiration (next Friday, Aug 21):

Profits of above 48.85, or up 2.9%

This trade idea risks a little more than half of the implied one-day earnings move and has 7 trading days to play out.

Obviously you need to get 3 very important things right in the next week to just break-even, first and foremost direction, then the magnitude of the move and of course timing.

OR

For those who are mildly bullish, think the quarter will be ok, but poor visibility on guidance I might consider a call calendar…

Bullish Trade Idea: CSCO ($47.50) Buy Aug – Oct 50 call calendar for 75 cents

-Sell to open 1 Aug 50 call at 50 cents

-Buy to open 1 Oct 50 call for 1.25

Break-even on Aug expiration:

the ideal scenario is that CSCO is just below 50 on next Friday’s close, the short Aug call will expire worthless or can be covered for a small amount leaving you long the Oct 50 call for 1.5% of the current stock price and two months for the stock’s breakout to take hold.

Lastly…

For those who think the company misses and guides lower than a re-test of the low $40s could be in the cards in the coming weeks…

Bearish Trade Idea: CSCO ($47.50) Buy Sept 47.50 put for $2

Break-even on Sept expiation:

down 4% at $45.50, risks 4% of the stock price, or less than the one day implied earnings move.

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