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Look for Cisco to Rebound

The company's strong growth in emerging markets and performance in products such as the Nexus family of switches are reasons for optimism.
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The slow economic recovery has not been kind to telecom hardware manufacturer


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Cisco, which competes mainly with


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in the Internet router and switch markets, recently reported earnings for the fourth quarter of its fiscal year.

Because Cisco's quarter ends one month later than most tech companies, its performance is a good indicator of current economic conditions. Cisco's results did not meet analyst expectations, apparently because of soft demand for its relatively high-priced products. The earnings release also coincided with a poor U.S. employment report. Following these two announcements, the company's shares fell by 10%.

Based in part on the earnings report, we have reduced our stock price estimate for Cisco from $26 to $24.76. This relatively modest price reduction reflects our belief that the market is exaggerating the extent of Cisco's woes. Reasons for optimism include Cisco's rapid growth in emerging markets and the strong performance of products such as the Nexus family of switches. Our analysis follows below.

First, the bad news. If the economy continues to perform sluggishly, we expect demand for routers and switches to slacken. This would obviously hurt Cisco's sales growth. And because Cisco's products tend to be relatively expensive, its market share can be expected to decline during hard economic times. With this in mind we have reduced our switch and router market growth estimates for 2010 and 2011, by 3% to 5%.

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You can drag the trend-lines in the charts below to create your own forecasts for the bottom-layer switch and router markets, respectively, and see how they impact Cisco's stock price.

Here's the good news. Two main factors give us reason for optimism. One is Cisco's strong recent performance in emerging markets. In the fourth quarter of its fiscal year, revenues grew by more than 50% in India, more than 40% in Brazil and Mexico, and 35% in emerging markets overall.

Emerging markets currently constitute 11% of Cisco's revenues. We concur with management's view that Cisco has a major opportunity to grow its business in these markets, which should help it maintain global market share across different product categories.

We are also heartened by the impressive growth of certain Cisco router and switch product lines. For example, sales of Nexus series switches grew by 325% year on year and seem likely to help Cisco gain share in the bottom layer switch market. The next interactive chart shows our estimate of Cisco's bottom layer switch market share going forward. You can drag the trend-line to create your own forecast and see how it impacts the company's stock price.

Additionally, sales of Cisco's ASR and CRS series routers grew by 150% and 20% year on year, respectively, thereby strengthening growth in Cisco's edge and core router business segments and supporting its market share in these segments.

Overall, these results show that at least some of Cisco's customers are upgrading and expanding their network infrastructure as the economy recovers.

You can see the complete $24.76 Trefis price estimate for Cisco's stock




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