Saturday, September 28, 2013

Is Cisco Systems a Buy?

The market always looks to Cisco Systems'  (NASDAQ: CSCO  )  results because they are usually a good indicator of where technology is headed. The latest earnings report proved no different. Cisco discussed a slow but ongoing economic recovery that contains some notable differences in growth rates from various regions. It seems that different geographies and end markets are taking turns to outperform for one period and then disappoint in the next. It looks like the tech markets are set for more uncertainty in the second half.

Cisco reports mixed regional growth...

Cisco's 6% revenue growth in the fourth quarter was in line with its long-term targeted aim of 5% to 7%, so investors could be easily forgiven for thinking that it was just another quarter. However, the underlying story was the relative performance of each region.

Revenue from the Americas grew 7%, and Europe, the Middle East and Africa (EMEA) grew an impressive 12%, but this quarter Asia-Pacific, Japan and China (APJC) actually fell 3%. Moreover, Cisco saw noticeably varied performance within the 8% growth recorded in its emerging markets. India and Mexico recorded double-digit gains, while the Brazil and Russia were flat with China down 6 %.

...and mixed industry growth too

It wasn't just a regional issue. In terms of orders by customer, enterprise declined 2% (with particular weakness in EMEA) although commercial grew 5%, and the global public sector grew 6%. The latter is notable because three quarters saw weakness in the public sector. In addition, service-provider orders grew 6%, and this comes after whole swathes of the tech industry had reported weakness in service-provider spending in the first quarter of 2013.

Furthermore, there was even some significant variability within Cisco's sales. Starting with its core sales, switching had a good quarter as new products were released, but routing had another weak set of results. There was also some bad news with services revenue only growing at 5.6% when Cisco plans for 9% to 11% for the next three-to-five years.

Its core activities of switching, routing, and services typically make up 68% to 69% of Cisco's total sales.
Source: Company accounts

What it all means to the industry

Investors should expect more unpredictability in the tech market. Oracle's (NYSE: ORCL  ) recent results were also disappointing. In common with Cisco, it cited US and EMEA license growth in line with expectations, but saw weaker conditions in China and Brazil. The variance in emerging market performance is worrying because a lot of tech companies spent last year relying on the BRICs for their growth prospects.
Indeed, International Business Machines (NYSE: IBM  ) reported an overall revenue decline of 3% in its results in mid-July with growth in the BRICs being flat. IBM's results presaged what Oracle and Cisco would say about regional growth, and it also gave a cautious outlook on Brazil and China. On a more positive note, the one key theme from all three earnings reports is that the US enterprise sector is outperforming.
However, investors need to be cautious over expecting too much from the government sector. Austerity measures and sovereign debt issues are not going away anytime soon, and order growth could continue to be lumpy in future quarters.
What to do with the big three?

Frankly, if you are thinking about investing in any of these three companies, then you need to forget about expecting too much help from the macro-environment. IBM's prospects are about its internal restructuring in order to focus on higher margin sales rather than pure revenue generation. Oracle is managing a shift in its revenue to cloud-based software, while also undergoing a transition to new hardware product systems.
One thing that all three have in common is prodigious cash generation, and they currently trade on historically attractive free cash flow yields.
IBM Free Cash Flow Yield Chart
IBM Free Cash Flow Yield data by YCharts

In Cisco's case, you are looking at business that just generated around $11.7 billion in free cash flow, and has over $33 billion in net cash and investments. These figures represent significant percentages of Cisco's current market cap of $129 billion.

Ultimately, the case for buying Cisco remains the same as before these results. Top-line growth will be hard to generate organically (particularly from its switching and routing sales) but its cash generation and assets mean that it can make acquisitions in its non-core segments.

What Cisco needs to do

Here is a breakout of its core and non-core (collaboration, service provider video, wireless, security and data center) revenue growth.
Source: Company accounts
Cisco's challenge is to carry on making acquisitions in order to generate growth in a slow economic environment.  In this way it can also help generate growth in its service sales. As a long-term investment proposition, the stock remains compelling, but just be prepared for some short-term disappointments along the way. Global economic growth remains slow and patchy

Friday, September 27, 2013

Quest Diagnostics, Not Sexy, But Good Value in an Expensive Market

End market conditions aren't great for diagnostics information services company Quest Diagnostics  (NYSE: DGX  ) , but that doesn't stop it from being a good value. If you're looking for a value play whose prospects are tied to its internal execution rather than the economy, Quest could fit the bill. It's worth a look for investors looking to balance their portfolio.

Quest's quest gets harder

It's been a tricky year for companies servicing hospitals, and Quest has suffered as physician office visits and hospital admissions have come in lower in the first half of 2013 than in 2012.
Indeed, during its conference call, the company outlined that growth "is not as strong as what we thought we were going to see this year." Moreover, after being "encouraged by April numbers," conditions appeared to get worse. Subsequently, Quest cut its full-year revenue guidance to a decline of 1% to 2%, from its previous forecast of flat to 1% growth. In addition, the high end of earnings per share guidance was cut by $0.05, leaving the new range at $4.35 to $4.50.
It's never good news to see a company cutting guidance, but Quest's real aim this year is to restructure its business so it can regain any market share lost to rivals like LabCorp  (NYSE: LH  ) and Bio-Reference Labs (NASDAQ: BRLI  ) . Quest's management has acknowledged that it hasn't grown in line with the market , and this can easily be seen by looking at its growth rates compared with those of its peers.
LH Revenue TTM Chart

Its chief competitor, LabCorp, managed to grow its organic volumes at 1.4% in the last quarter and is forecasting 2% to 3% revenue growth for the full year. This is a far cry from Quest's forecast of declining revenues.

The real question is: What is Quest doing to get back to industry growth rates?
Quest restructures and goes for growth

Earlier in the year, Quest outlined its five-point program to get back on track; I discussed this in more detail in a previous article. The good news from the company's latest earnings results is that it appears to be executing well on the plan. The recent sale of its royalty rights to ibrutinib (an experimental cancer therapy) to Royalty Pharma for $485 million  is in line with its strategy to focus on diagnostic information services. The proceeds of the disposal will also help it to return cash to shareholders.
Furthermore, the management's restructuring initiatives are being implemented. The targeted run-rate savings of $600 million by 2014 were declared to be "tracking very well" with plans. The really interesting news relates to its growth plans, however. A quick look at the chart above shows that its much smaller rival Bio-Reference has achieved much faster growth rates. This is largely due to Bio-Reference's focus on higher growth areas like esoteric testing, molecular diagnostics, and women's health. It seems that Quest has been watching closely.
Indeed, the company has now focused on driving growth with its esoteric testing services, and it recently announced an extension of its relationship with women's health company Hologic (NASDAQ: HOLX  ) . The deal's main focus is on Hologic's APTIMA product range -- which includes tests for human papillomavirus, chlamydia, and gonorrhea -- and allows Quest to offer new tests to its customers. Moreover, Quest is planning to release tests that create "a solution around BRCA1 and BRAC2." These are genes whose mutations can be tested to try and ascertain a women's susceptibility to breast cancer.

Where next for Quest Diagnostics?

Ultimately, its second-quarter results were disappointing from a top-line perspective. The investment case for the company remains in place, however. Its guidance for free cash flow generation is around $750 million, representing around 6.1% of its current enterprise value. Remember that this is in a year of raised capital expenditures due to the restructuring and investment.
Analysts have earnings rising 8.5% in 2014.  If Quest achieves its aim of $600 million in cost savings and getting the company back to 4% revenue growth rates, then its current valuation of 13.5 times earnings estimates for 2013 will start to look cheap. It's an interesting value proposition.

Thursday, September 26, 2013

TJX and Ross Stores are Still the Pick of the Retail Sector

If the markets needed any more proof that off-price retailers are likely to outperform the market, then they surely got it with the latest results from TJX (NYSE: TJX  ) and Ross Stores (NASDAQ: ROST  ) . Both companies beat their internal guidance in terms of sales and earnings, and demonstrated that they have plenty of growth potential in the years ahead. Despite their strong share-price performance over the last year or so, it's not too late to buy into the story.

Still growing

Both companies generated some pretty impressive comparable-same-store sales growth in the second quarter, and it's noticeable how correlated their sales growth has been over the last few years. In addition, note that they are both lapping some strong growth numbers from last year.

source: company accounts

In addition, they both raised same-store sales guidance for the year.

TJX Companies raises guidance

Following better-than-expected same-store sales growth of 4%, TJX raised its full- year comparable-same-store sales estimate to 2%-3% growth from its previous range of 1% to 2%.

In addition, its new EPS-range forecast of $2.74 to $2.80 represents adjusted underlying growth of 11% to 13% over last year. Furthermore, the commentary around the results suggests that it is achieving its objectives for 2013. There are four key areas that investors need to focus on in this context.

Firstly, TJX's European expansion plans are working well, with 6% comparable same-store sales growth recorded in the quarter. European segment margins also increased to 5.2% from 3.5% last year, and given that TJX's Marmaxx (T.J. Maxx and Marshalls stores) currently generates margins of nearly 16%, it's not unreasonable to believe that TJX can increase European profitability in the near future. Europe presents a significant growth opportunity.

Second, its home-goods segment grew profits by over 34% in the quarter, and given the resurgence in the U.S. housing market, TJX can expect more to come in the future. Home goods now contribute 9.4% of segment profits from a figure of 8% last year.

Third, one of its objectives is to widen its appeal beyond its traditional customer base by marketing itself more to younger consumers. Indeed, on its conference call, it declared that the plans were working.

Our increase in customers is coming from a younger group of customers" and "we're absolutely bringing in younger customers. That's where our increase is coming from.

The final objective is the second-half launch of an e-commerce-enabled T.J. Maxx website. Plans for the site were described as being 'on-track,' and since retail companies like VF Corp are generating good growth from e-commerce expansion, the future looks bright for this initiative.

What about Ross Stores?

While the first chart indicates that its fortunes are very similar to TJX, there are some differences. Ross isn't chasing e-commerce growth or making aggressive international expansion plans, but it has managed to generate some impressive traffic growth over the last few years. In addition, its focus on improving execution has lead to its profit margin rising to 8.4% from 7.7% last year, and this compares favorably to TJX's overall profit margin of 7.4%.

However, the one area where Ross under-performed TJX was in its home-goods sales, which only rose inline with its total sales growth. Similar to its rival, Ross Stores continues to beat its own guidance.

source: company presentations

Where next?

Essentially, both companies are executing well in their core U.S. off-price clothing markets. While other retailers are suffering from the ongoing cautiousness of the consumer, the off-price concept seems tailor-made for consumers seeking opportunities to avoid paying full price.

In addition, running an off-price retailer requires a significant amount of experience in purchasing inventory and merchandising.  Arguably, this provides TJX and Ross with some significant barriers to entry that aren't replicated across many other parts of retail.

It's been a difficult year for the retail sector with consumers being challenged by payroll tax increases, sequestration fears, tax-refund delays and some unusual weather conditions. However, both companies have demonstrated that they can outperform in a difficult retail environment, and with the U.S. economy continuing to generate moderate GDP growth of 2% to 3%, the off-price retailers have longer to run.

Wednesday, September 25, 2013

Cognex is Seeing Excellent Growth

Many technology companies promise growth in the distant future, but Cognex (NASDAQ: CGNX  ) is starting to deliver on its potential right now. The company is the world leader in machine vision systems used in capturing and analyzing data from automated manufacturing processes. With the stock up over 52% in the last year, it's time for investors to look at more closely at this growth play.

Cognex starts to deliver

Every assembly line manufacturer or logistics operation needs to monitor production processes thoroughly, and Cognex's machine vision systems offer the ideal answer to this problem.Its systems help to ensure assembly line quality control and, insure that the plant is working at optimal efficiency. Cognex's growth opportunity is to increase penetration of its systems within manufacturers' processing plants.

In addition, the company has been trying to expand out of its core end-markets like automotive, and into less cyclical verticals like pharmaceuticals, logistics, beverages, and food. The good news is that its largest core end market (automotive makes up around 25% of its factory automation business) is doing relatively well this year. Furthermore, Cognex is starting to see some large orders coming in from its targeted growth areas like logistics and emerging markets.

Logistics and emerging markets

The company has long looked at the logistics market as a potential growth area, and its latest second-quarter results came with the announcement of a large order from a major logistics firm, such as UPS or FedEx. In previous conference calls, Cognex's management was keen to highlight that the logistics companies tend to take time to assess new technologies. However, the latest conference call saw company officials take a more bullish tone:

"The customer we reported winning the large order from is one of many significant customers we expect to have in that market. I would say it was the first breakthrough, but we expect more orders from that customer but perhaps, more importantly, from other large players in that market to come over the next quarters"

Cognex has discussed logistics as being a $250 million market opportunity, and any orders here will obviously help to generate interest in the broader $1 billion ID-products market that encompasses sectors like retailing and packaging. To put this into context, Cognex's revenues for 2012 were around $324 million.

With the global manufacturing center of gravity shifting toward emerging markets, regions like China are going to become increasingly important for companies selling industrial solutions. Indeed, within its key factory automation segment (78% of revenues), Cognex reported that $10 million (or nearly 15%) came from China. With its factory automation sales to China growing at 41% in the quarter, it's fair to assume that China's contribution will get bigger in future quarters.

Is it macro?

As ever, investors will want to assess whether Cognex's strength is due to macro factors or some specific industry or company strength. One of its key competitors, Danaher (NYSE: DHR  ) , also reported good numbers in its product ID sales. In its latest second quarter results (delivered in mid-July) Danaher reported its product identification revenues were up mid-single digits with sales rising in all its key regions. That's pretty good growth given that Danaher's overall sales were only up 2.5%, and it suggests that this segment of manufacturing is capable of growing faster than the market.

Given the connection between the two companies (Cognex's current CEO was formerly a VP of Danaher's product identification business) and Danaher's highly acquisitive nature, it's not hard to view Cognex as a potential target for its much larger competitor.

Where next for Cognex?

Cognex's excellent execution hasn't gone unnoticed by the market, and its valuation is now looking high.

CGNX P/E Ratio TTM data by YCharts

Looking ahead, the analyst consensus is for $1.98 in EPS for 2014. With the current price around $56, this would put Cognex on a forward P/E ratio of around 28. The chart above suggests this is a fair value for the stock, so it's hard to argue that the stock is a raging buy.

Cognex certainly has the capability to generate upside surprise (new logistics deals, expanding sales in new sectors, etc.), but you will need to assume this in order to see the stock as undervalued right now. This is a high quality company, but investors need to watch it closely for earnings upgrades and/or a better entry point.

Citrix is Dealing Well With Changing Trends in IT

It helps to have powerful friends, and very few companies have allies as strong as IT virtualization specialist Citrix Systems (NASDAQ: CTXS  ) . With partners Cisco Systems (NASDAQ: CSCO  ) and Microsoft (NASDAQ: MSFT  ) helping to push some of Citrix's newer solutions, the company looks well-positioned to grow, even as its core desktop virtualization sales are slowing.

Citrix's changing end market

Desktop virtualization allows companies to centralize their application software management so that their hardware (PCs) become virtual devices. Installing new applications on a single central computer -- and having those changes instantly show up on every employee's PC -- makes managing IT infrastructure a lot easier for big companies.

The big story in computing over the last few years has been the shift from desktop PCs toward mobile devices and cloud-based solutions. This powerful trend has left some tech behemoths, like Microsoft and Intel (NASDAQ: INTC  ) , struggling to remain current.

Simply put, Microsoft's Windows has very low penetration on mobile devices. Meanwhile, Intel has been too slow to develop chips for the new ultra-mobile world, and the second half of 2013 is going to be an important period in its long-term plans. Within those six months, Intel is releasing a few new chips with which it is trying to establish a foothold in the ultra-mobile market.

All of this forms the basis for discussion of the challenges facing Citrix in 2013. If PCs are no longer the dominant force in computing, and Windows is no longer the default standard operating system, where does this leave Citrix's core desktop virtualization market?

XenMobile to the rescue

Citrix hasn't been slow to adjust to the changing reality. In the first quarter, it released its enterprise mobility solution, XenMobile. Unfortunately, it seems to have affected its growth pattern. Indeed, at the time of its first-quarter results, Citrix argued that the XenMobile release caused customers to delay orders as they assessed which type of solution was optimal. A chart of product revenue growth reveals how choppy the company's growth has been as a consequence.

Source: company accounts

Growth in products and licenses is the key to growth in the other revenue streams.

The second quarter saw an impressive bounce back in overall product and license sales growth. But within that, mobile and desktop only generated a 2% increase. So, even though mobile and desktop revenue actually rose 11%, Citrix's future growth is not assured.

However, on the conference call, management was keen to stress that: "...regarding mobile and desktop, I believe that the growth will accelerate as we look into Q3 and Q4. And that's a function largely of productivity starting to flatten out and mobile starting to ramp."

Desktop virtualization and application delivery controllers

Alongside the plan to push XenMobile -- which, by the company's own admission, is hurting its efforts to sell its stand-alone desktop solutions -- Citrix is also releasing its latest desktop virtualization solution, XenDesktop 7. Microsoft has a vested interest in helping this solution succeed because it brings Windows virtual desktop and apps under one structure, encouraging corporations to keep running Windows.

While XenMobile and the XenDesktop 7 are about generating future growth in mobile and desktop, the current star performer is Citrix's networking and cloud division. The latter grew revenue at a whopping 46% in the quarter, with product license revenues up 54%. In fact, the share of total revenues coming from networking and cloud solutions has risen from 16% in 2010 to around 22% so far this year.

Source: company accounts

The biggest contributor to growth in networking and cloud revenue came from Citrix's application delivery controller, or ADC, NetScaler. F5 Networks (NASDAQ: FFIV  )  is the global leader in this market, but Citrix's NetScaler has a couple of key advantages.

First, Citrix is able to include NetScaler as part of its virtualization offerings. Indeed, it announced that it signed 550 desktop virtualization orders in the quarter on this basis. Second, Cisco Systems is a key partner of Citrix, and since Cisco stopped investing in its own ADC (called ACE), the two companies have teamed up to sell NetScalers.

There is more growth to come. On the conference call, management argued that the replacement orders for Cisco's ACE only contributed a "minor amount" to the current results. In other words, Citrix still has a significant amount of Cisco's installed base of ACE customers to target in the future. Naturally, F5 will also fight hard for this business, but it's difficult to conclude that Citrix isn't taking market share at the moment.

The bottom line

Essentially, Citrix investors should be looking for a few things going forward:

  • A strong return to mobile & desktop product license growth in the second half

  • Ongoing sales execution from NetScaler

  • Its partners, Cisco and Microsoft, continuing to integrate functionality with Citrix's solutions

The desktop virtualization market is far from dead, and still has some good growth catalysts. In addition, the changing tides in IT spending are about integrating solutions across multi-platforms, so Windows still has a key role to play. Meanwhile, XenMobile and NetScaler promise to offer alternative sources of growth.

Finally, Citrix's valuation does not look historically expensive.

Provided it can execute on the above points, the analysts' consensus price target of $80 looks achievable. It's well worth a look.