The market isn’t sparing Cisco Systems (NASDAQ:CSCO) from the brutal sell-off triggered by the coronavirus pandemic. Granted, a recession would have a negative effect on the company’s short-term performance. But the tech giant should also profit from the stay-at-home policies that are being enforced in several countries. And with long-term tailwinds that should still materialize, Cisco has become an attractive investment opportunity for patient investors.
Cisco’s core business consists of selling network devices and software. During the last quarter, the company’s infrastructure platform segment, which mostly includes computer networking solutions, represented 54.4% of the total revenue. That segment is exposed to the expected worldwide computing infrastructure reduced spending. Because of the uncertainties related to the coronavirus outbreak, the research company IDC communicated a pessimistic scenario where IT spending is forecasted to increase by only 1% in 2020, compared to 4% previously.
But Cisco also proposes communication solutions such as Webex and Jabber for remote workers to communicate and collaborate from anywhere. These solutions represent an important part of the company’s applications segment that reached 11.2% of the total revenue during the last quarter. In the context of the work-from-home policies that are enforced because of the coronavirus outbreak, Cisco has seen a 22-fold traffic increase in its Webex cloud backbone over the last few weeks. A part of this growth is due to the expansion of free Webex offerings to support the quick implementation of work-from-home policies, though. But this development is likely to benefit Cisco over the long term since it gives enterprises the opportunity to become familiar with these types of solutions.
Cisco’s security segment also includes cloud-based solutions such as Umbrella and Duo Security. These tools protect and authenticate employees from anywhere, which complements the use of Cisco’s remote communication tools. Again, Cisco doesn’t provide detailed information about the performance of these individual solutions, but CEO Chuck Robbins highlighted during the latest earnings call that Duo Security and Umbrella were important growth drivers for the company’s security business, which represented 6.2% of total revenue during the last quarter. The work-at-home measures that are being taken to deal with the coronavirus situation are likely to boost the demand for these cloud-based security solutions.
The effect of the coronavirus outbreak remains uncertain, but the company can stomach such a challenging environment for many years. Its cash exceeded its total debt by $11.1 billion at the end of last quarter. Management can also use this comfortable safety net to acquire tech stocks that have recently become cheaper.
In addition, Cisco has shown its capacity to generate free cash flow over the last decades, including during the financial crisis of 2008. And despite short-term volatility, free cash flow has been steadily growing over the long term.
Looking forward, Cisco is still exposed to the growth opportunities 5G and 400G technologies represent over the next years. For instance, the giant telecommunications provider Verizon recently announced an increase in its 2020 capital program range to accelerate the deployment of 5G. And IDC forecasts 5G infrastructure spending to increase annually by 118% by 2022.
Following Cisco’s latest results one month ago, I argued its valuation was reasonable at that time. Since then, Cisco’s stock price dropped by 34%, which led to an increase in its dividend yield to 4.3%.
A recession should have a negative effect on the company’s results in the short term, and the stock price could remain volatile. But Cisco seems ready to face these challenges, and its long-term tailwinds remain intact. Thus, the market is now offering long-term investors an opportunity to consider buying Cisco’s stock at a low forward P/E ratio of 12.2.