August 11, 2011 / 2:12 PM / 7 years ago

Cisco bulls may underestimate tough road ahead

SAN FRANCISCO (Reuters) - Cisco Systems Inc still faces tough challenges with tight public spending and fears of a new economic downturn, analysts warned, after the giant Silicon Valley company ended a year’s worth of disappointing sales forecasts.

Shares of Cisco surged over 16 percent on Thursday, a day after Chief Executive John Chambers delivered quarterly results suggesting that tough measures to return the company to health were paying off, impressing investors who had braced themselves for the worst.

“Cisco was left for dead,” said Gleacher & Co analyst Brian Marshall.

“Investors felt like the earth was salted for Cisco’s opportunity, that their core markets are mid-single digits businesses and ... that Cisco would forever be a one- to two-times GDP grower relegated to the status of an IBM (International Business Machines Corp or an HP (a Hewlett-Packard Co),” Marshall said. “That remains to be seen.”

Chambers, who in April famously warned that the world’s leader in Internet networking equipment had lost its way and a year ago spoke of “unusual uncertainty” in the economy, on Wednesday said he expects gradual improvement in the business.

He signaled that demand from governments and corporations for networking might not be as bad as had been feared.

The Street applauded the upbeat results and outlook, but some analysts questioned whether it was enough to justify such a large stock surge and said much of the jump was probably a reflection of recent broad market volatility.

Cisco’s shares, which had lost a third of their value since the beginning of 2011, were trading at $15.99.

Those analysts warned investors not to underestimate how much public spending budgets could be cut next year and said Cisco might need to prune more product lines and perhaps exit some more unprofitable businesses.

The one-time Wall Street darling, which depends on government spending for about a fifth of its revenue, said in July it would cut 15 percent of its workforce and sell a set-top box factory in Mexico as part of an effort to slash annual expenses by $1 billion.

“Its great that they’re tightening their belts and kind of taming the beast a bit, but there are some fundamental misalignments they still need to address.” Mizuho Securities analyst Joanna Makris said.

She said a budget flush as the U.S. federal government wraps up its fiscal year in September would help Cisco in the current quarter, but government spending next year is less clear.

Brokerage Stifel Nicolaus raised its rating on the stock to “buy” from “hold,” and said Cisco seemed to have left the worst behind, echoing many analysts’ opinions.

“Although the macro environment and public sector spending could continue to put pressure on switching and overall sales, the company is starting to see some stability in orders,” the brokerage said in a research note.

Cisco forecast current-quarter revenue up 1 to 4 percent, in line with expectations. Its fiscal fourth-quarter results were a bit above forecasts. Gross margins, though, came in at 62.7 percent, dipping from 63.9 percent in the fiscal third quarter.

“Gross margin is always a very important issue for a tech company and their gross margins continued to slide. Their topline growth is pretty anemic. And they just made major cost cuts, so we still don’t know their full impact on the total business,” said William Blair analyst Jason Ader.

Editing by Gerald E. McCormick

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