Cisco Raises Alarms for Telecom

All eyes are on the retail implosion but there was an important tech report that may go unnoticed.

Cisco (CSCO) is always a key read for the markets. It is an April-end quarter which provides us some important insight into hardware OEM performance for most Q2 earnings reports.

There is an added layer to this report as it is viewed as a defensive play, so the price reaction is of particular interest. 

Investors expected the restricted supply environment to have a negative impact, however, the magnitude of the impact was greater than anticipated. 

Cisco reported third-quarter revenues of $12.8 billion, well below the expected $13.3 billion. Management pointed to Russia/Ukraine, China lockdowns, and component shortages as key reasons for the revenue shortfall. 

Softer-than-expected performance in both its Products and Services segments was exacerbated by the company’s exit of the Russian/Belarus markets which was a $200 million headwind. The supply chain constraints should continue in Q2 as June and July mark the periods which will be most affected by China’s ‘zero tolerance’ policies. 

Product order growth of 8% marked a deceleration from the 33% posted in the prior quarter. Enterprise growth collapsed from +37% to flat. There was a -2% drag from Russia but these results include price increases of +7% and +10% over the past six months. Making this deceleration more notable is competitor Arista Networks (ANET) not only beat expectations but guided materially higher. This provides more evidence that ANET is grabbing market share from the tech giant. 

The magnitude of the shortfall suggests these problems could persist for the next few quarters. Demand remained firm but the risk of further economic slowdowns could impact order growth. There are areas where CSCO operates that should continue to see growth (5G, WiFi6, security, etc).

Cisco expects Q4 revenues to decline -3% at the mid-point which is well below analyst expectations for 6% growth. To be fair, the company did say it was being cautious with its outlook. The typical sandbagging management usually provides to the street. 

CSCO did beat bottom-line expectations which suggests it has the pricing power to offset some of the order shortfalls. Margins showed a better story as the 65.3% gross margins, and 34.7% operating margins both outpaced expectations. Software represented 29% of revenues in the quarter and helps boost the bottom-line margins. 

Shares of CSCO tumbled 13% in reaction to the news. It is now trading around the $40 area which is the same level it traded at heading into March 2020, just ahead of the pandemic. There has been damage done to the charts but it should start to find some support in this area. 

Investors will want to hold off buying until there is greater evidence of normalization in the supply chain and order growth patterns. 

China’s lockdown measures were announced on March 27. CSCO states this had a negative $300 million impact on the top line as it was unable to get key components for power supplies. These forced closures are expected to persist until June 1 although we have seen signs of factories re-opening. We would expect to see, at minimum, a similar impact to the upcoming Q4 results. 

CSCO shares should trade in the $40-44 area with greater potential to the downside in the coming weeks. But if we start seeing early signs of a recovery in the supply chain then we will want to revisit Cisco as a buy. 

We wanted to highlight a few names that are fighting to hold support. These companies have exposure to Cisco and should be on your trading radar for possible breakdowns if sentiment continues to sour. The primary read-through from major channel players and EMS providers suggests the supply disruptions worsened during the quarter. 

  • EMS Providers: 
      • Flex Ltd (FLEX)- Holding support at the $15-16 area.
      • Jabil (JBL)- Holding support above the $55 area.
  • PCB (circuit board) Manufacturer:
    •  TTM Technologies (TTMI)– Stock has been rangebound between $12-15. 
  • ePlus (PLUS)- CSCO accounts for 40% of revenues. Stock fighting to hold above $54 support.

The report will raise a red flag on other Hardware OEMs:

  • Hewlett Packard Enterprise (HPE)– Stock clipped below its 50-weekly moving average in reaction to the CSCO news.
  • NTAP (NTAP)- Shares have been in a steady downward decline and are now testing key support at the 200-weekly ($66). 
  • Pure Storage (PSTG)– Stock coming into support around the $24 level. Shares are down 21% YTD but are still up 43% over the past 12 months.

Peers to watch include:  

  • Ciena (CIEN)– Stock slipped to a 52-week low following the CSCO results. Testing key support at the $50 level.
  • Juniper (JNPR)– JNPR shares are testing a major support level at this $28 area.
  • Arista Networks (ANET)– Remember, there is speculation that CSCO’s losses have been ANET’s wins. If you are looking for a bounce in the space, then this is the name you want to play. The stock slipped below the weekly 50-sma this week. 

Netgear (NTGR)- The chart looks abysmal as it has been on a steady decline since early 2021. The RSI sits at a meager 27 highlighting the negative sentiment around the name.