For weeks now, tech companies have been warning investors that the global chip shortage is crimping their ability to grow, inflating costs, and depressing sales.
The issue cropped up repeatedly on earnings calls. Apple (ticker: AAPL) warned that its revenue guidance for the June quarter would have been as much as $4 billion higher if it had enough parts to meet demand for Macs and iPads. Poly, the maker of videoconferencing hardware and headphones, cited the parts shortage for its recent earnings miss. Cisco Systems (CSCO) hammered home the point this past week, forecasting disappointing earrings because of the tight parts supply.
Cisco shares swooned 7% in late trading after the earnings report. But a fascinating thing happened the next morning. The networking giant’s stock opened about 4% lower, and then kept inching higher, eventually closing up 1%. In effect, investors decided that the parts shortage doesn’t really matter, at least not in the long run. Long-term thinking from the stock market. Imagine that.
Initially, the component issue overshadowed what was otherwise an impressive performance, by far Cisco’s best since the start of the pandemic. For the fiscal third quarter ended May 1, Cisco reported revenue of $12.8 billion, up 7% from a year ago. It was the first quarter of revenue growth in more than a year, and the strongest topline increase since 2018. In a positive sign of future growth, orders were up 10% year over year, the best increase since 2012.
Revenue and orders were up in every geography. Cisco saw double-digit order growth from telecom, small and midsize businesses, and the public sector. Enterprise orders were flat, an improvement from declines of 9% in the second quarter and 15% in the first.
The outlook was more complicated. For the fourth quarter, Cisco projected revenue growth of 6% to 8%, ahead of the Wall Street consensus of 5.5%. The company projected non-GAAP profits of 81 to 83 cents a share, below the Street consensus at 85 cents, with a non-GAAP gross margin of 64% to 65%, down from 66% in the third quarter.
And you know the issue. Cisco is paying up to get parts, and absorbing higher airfreight costs to get them delivered. CEO Chuck Robbins told investors that revenue guidance might have been two percentage points higher if the company had enough components. Robbins said the issue will take time to fix, likely dragging on at least through the end of the year.
While that’s frustrating, and no small issue, it is hardly fatal. And it shouldn’t overshadow the fact that the company is seeing improved demand. Cisco is also getting traction on its push to transform more of its business to software. As CFO Scott Herren told me last week, the company now has a $14 billion software business based on revenue. That alone, he points out, makes it a bigger software company than Adobe (ADBE).
Parts shortage or not, Cisco is going to be a beneficiary as businesses reopen and start spending on IT infrastructure again. Morgan Stanley analyst Meta Marshall last week argued that the company has “underappreciated earnings power.” It’s about to see “a meaningful investment cycle as employees return to work.”
Cisco was left out of the 2020 tech-stock rally, falling 4% while the Nasdaq Composite index leapt 43%. While many enterprise software companies continue to trade at challenging multiples, even after the recent selloff, Cisco is priced at a relatively modest 15 times estimated profits for this year and at less than six times projected sales. It pays a nearly 3% dividend, buys back stock, and is nearing a period of extended growth. It’s a play on the cloud, 5G, security, and edge computing. For investors, those are the components to focus on.