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Over the last couple of months, I’ve explored the capital return plans of Intel (INTC), Microsoft (MSFT), and Apple (AAPL). Those are three large-cap tech giants that are returning billions to shareholders in the forms of dividends and buybacks. One name on that list I really haven’t examined intensely is Cisco Systems (CSCO). The networking giant is another name with an impressive dividend and solid buyback. The question today for investors is whether or not they should consider this name a capital return dream stock. Should Cisco be grouped in with the other three names? Let’s take a look.
Recent uses of cash:
To be a capital return dream stock, a company obviously has to return a good chunk of cash to its shareholders. The table below shows some key cash numbers that investors will key in on. These have been taken from the most recent 10-K, and I’m only including the line items explicitly shown in the table. For instance, I have not included shares repurchased for tax withholdings on vesting of restricted stock units. Dollar values are in millions. Years below are fiscal, which end in July.
Cash flow from operations has increased nicely. Obviously, the more cash a company produces, the more it can return to shareholders, unless of course it puts it back into the business (capital expenditures). Cisco has made some large acquisitions recently. They acquired NDS last year for $5 billion in total considerations, which you can see in the business acquisitions number above. Even with that large purchase, the amount of dividends paid and buyback line items on the cash flow statement still increased. Cisco has announced the purchase of Sourcefire (FIRE), which will reduce its cash balance by approximately $2.7 billion. That should close in the 2014 fiscal year, so that will factor into the business acquisitions category.
Just a couple of years ago, Cisco did not pay a dividend. It started in 2011, and has increased it greatly since. You can see that in the table above, as dividend payments have risen from $658 million to over $3.3 billion in just two fiscal years. I’ve charted the dividend date below, using payment dates, and I added 1/20/11 as an artificial date to show that the dividend was zero at that point.
Cisco has gone from no dividend to $0.17 a share per quarter in just over two years. That’s a great increase, and it makes Cisco a decent dividend play. Cisco does not have the highest yield in large cap tech land, as I’ll show later, but there is room for the dividend to increase nicely in future years. I’ll show why in the next section.
Balance sheet update:
To execute a strong capital return plan, a company must have a strong balance sheet. Cisco fits in that category. The following table shows some key balance sheet metrics, which I’ll use to further analyze the name. As above, dollar values are in millions.
*Liabilities to Assets ratio.
One key number is the domestic held part of the cash balance, which has increased nicely in recent years, but will decline after the Sourcefire purchase is complete. Cisco can only use its US based cash resources for dividends and buybacks, so the above increase is very nice. You’ll notice that a large portion of its cash pile is located outside the US, which is not uncommon for a large-cap tech name. While some of Cisco’s short-term ratios have decreased a little, the company has reduced debt a little and the liabilities/assets ratio has improved. Cisco’s balance sheet is in great shape, and I wouldn’t be concerned even if the current ratio came down a little more.
Comparisons to other tech names:
I mentioned above that foreign funds can’t be used for dividends and buybacks. Those funds, if brought back into the US, would be open to repatriation taxes, which many companies want to avoid. The following table shows a comparison of top tech names, including Google (GOOG), and their domestic versus foreign cash piles.
*Apple’s number includes cash, short and long-term investments. The other names are just cash and short-term investments.
**Numbers are rounded, so foreign and domestic held numbers could be slightly off the actual amount.
Cisco has the 3rd highest percentage of domestic cash. Even if you take out the Sourcefire money, it would still be in that 3rd place spot. Cisco is in a better position than Microsoft, which just announced a huge dividend increase and new large buyback. It will be interesting to see if Microsoft adds any debt to pay for its capital returns, or whether they can do it from current cash flows.
In terms of the dividend, Cisco remains in third place. The following chart shows Cisco against the other three dividend names, with annual yields as of Monday’s close.
Cisco remains a bit behind Microsoft and Intel, two names I don’t think it will challenge anytime soon. Cisco does maintain a dividend yield advantage over Apple at the moment, but if you put Apple back below $450 where it was recently, Apple is close to Cisco. Also, Cisco does not have the buyback power of Apple currently.
Where Cisco goes from here:
It’s been a little over a year since Cisco announced its promise to return at least 50% of free cash flow to investors in the form of dividends and buybacks. I’ve already shown above how they’ve increased the dividend nicely, and I expect further increases in the coming years. I would not be surprised if Cisco tries to keep its dividend around the 3% annual yield area when it announces each yearly raise, assuming the stock were to rise over time.
So the interesting item to think about is the buyback. At the end of the latest quarter, Cisco had approximately $3.1 billion remaining on its current buyback plan. Based on recent quarterly numbers, that plan should end roughly in a year, give or take a quarter or two. So I would start to look for an announcement on a potential new plan over the next couple of quarters.
Cisco certainly has the financial flexibility to continue buying back stock. It could choose to announce a smaller plan, say $10 billion, that could be executed over a couple of years, or it could announce a larger plan with no expiration, like Microsoft just did. The interesting decision is whether or not Cisco chooses to take out debt and accelerate a plan. Apple recently did that, and Apple might even expand its buyback even more. An expanded buyback would help boost Cisco’s earnings per share right away, but as I showed above, it does have a bit of debt already.
Would it be wise to take out debt for buybacks? It would only if it would be short-term debt with lower interest rates. That way, you could buy back shares yielding 2.70%, and have a cash flow savings on the difference between that yield and the after-tax cost of interest. It would not make sense to buy back stock if Cisco needed to take out longer term debt, like say 30 year debt, with an interest rate of 4.50% or higher. At that point, the deal would be cash flow negative up front.
Final thoughts:
Cisco appears to be a capital return dream stock, and if you don’t consider it one already, you probably should going forward. Cisco has bought back almost $80 billion in stock since 2001, and the company now has a solid dividend that has grown tremendously since its inception two years ago. The amount of Cisco’s buyback over the next few years will depend on Cisco’s acquisition pace, and the company has made two large purchases recently. Cisco’s dividend is between Apple’s and the Microsoft/Intel duo right now, where I feel it will remain for quite some time.
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