Cisco Systems, Inc.’s (CSCO) Bleak Outlook Hits Technology ETFs

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November 18, 2013 5:06pm NASDAQ:TDIV NYSE:IGN

new etfsOne of the tech bellwethers, Cisco Systems (NASDAQ:CSCO) once again disappointed investors with weak revenues and a bleak outlook in its fiscal 2014 first quarter release.

Though the company earnings of 48 cents a share beat the Zacks Consensus Estimate by a penny, it failed to deliver on the top line. Revenue grew 2% to $12.1 billion, but missed our estimate of $12.3 billion and well below management projection of 3%-5% growth(read: Forget Big Tech; Buy These ETFs Instead).

This sluggish performance was mainly due to weak demand in emerging markets like China and the impact of the recent government shutdown on business spending. Sales in Russia and Brazil dropped 30% and 25%, respectively, while sales in Mexico and China were down 18% in the quarter.

The US National Security Agency spying scandal has taken a toll on the sales of China and other emerging markets including Brazil, Mexico and India in the previous quarter and is expected to hamper the current quarter as well. This suggests that these nations may not be able to power broad CSCO growth in the future, and that the company may have to look elsewhere for earnings gains.

The network equipment maker expects revenues to fall as much as 8%–10% in this quarter due to sluggish emerging markets. It also projects earnings per share in the range of 45–47 cents, which is below the Zacks Consensus Estimate of 48 cents. Further, Cisco warned of challenging business in the coming months.

Market Impact

Led by the emerging market bearishness and some gloom over the company’s outlook, 17 analysts cut their target prices on the stock while two downgraded their ratings. This move spread pessimism on the growth of the network equipment company. This is further supported by our negative outlook as the stock has a Zacks Rank #4 (Sell).

This was obviously poorly received by investors in CSCO, leading to a sell-off. Cisco shares tumbled nearly 11% at the close on Thursday trading volume on elevated volume. The news also hurt the broad tech space since CSCO is a bellwether for many firms in the sector.

Due to this, a number of other players in the space also traded lower in the session, falling in tandem with Cisco. Some of the players include Hewlett-Packard (HPQ) – down 5.4%, EMC Corp. (EMC) – 1.94% and IBM Corp. (IBM) – down 0.73% (read: 3 Tech ETFs to Watch on IBM Revenue Miss).

This broad weakness is actually best represented by the following ETFs, as these funds have the biggest allocations to CSCO and thus could be the most in focus thanks to the earnings report, or any future selling in the segment should expectations fall for tech in light of CSCO’s announcement:

iShares North American Tech-Multimedia Networking ETF (IGN)

For a concentrated play in the networking space, IGN could be worth a closer look. The ETF follows S&P North American Technology-Multimedia Networking Index and holds 26 securities in its basket. Cisco takes the third spot at 8.69%, trailed by Motorola (MSI) and Qualcomm (QCOM) with 9.76% and 8.86% share, respectively.

The fund has accumulated $247.8 million while sees a good volume of nearly 52,000 shares a day. Expense ratio comes in at 0.48%. The fund saw a heavy loss of 1.91% in a single trading session yesterday while five-day return is still up 1.84%.

iShares Dow Jones US Technology ETF (IYW)

This is one of the most popular ETFs in the broad tech space, as it has about $2.9 billion in assets, and average daily volume of roughly 325,000 shares. The product tracks the Dow Jones US Technology Index, giving investors exposure to 142 U.S. stocks while charging 45 bps in fees and expenses.

CSCO occupies the fifth position in the basket with 4.58% of assets while Apple (AAPL), Microsoft (MSFT) and Google (GOOG) take the top three positions with a combined 37.42% share. The product is heavily skewed toward the hardware and equipment segments, as these make up for more than half of the portfolio. Software and computer services take the remaining portion in the basket.

After losing 0.5% in the Thursday session, IYW is still up 2.18% over the past five trading days.

First Trust NASDAQ technology Dividend Index Fund (TDIV)

This fund provides exposure to the dividend payers within the technology sector by tracking the Nasdaq Technology Dividend Index. The product has amassed about $239.5 million in its asset base while it trades in volume of roughly 87,000 shares per day. The ETF charges 50 bps in annual fees (read: 4 Ways to Grow Dividends with ETFs).

In total, the fund holds about 87 securities in its basket. Of these firms, CSCO takes the fourth spot, accounting for roughly 7.53% of the assets while Microsoft (MSFT), Intel (INTC) and AAPL are the top three components in the basket. In terms of industry exposure, the fund allocates one-fourth portion in semiconductor equipment, followed by software (15.40%) and computer and peripherals (14.70%).

The product lost about 1% in Thursday trading while its five day performance is +1.02%.

Bottom Line

The big emerging markets continue to face weakness adding worries for CSCO, pushing investors to sell shares of this tech giant. Should these worries continue, it could spell more trouble not only for CSCO, but also the broad tech ETFs and especially those counting on emerging markets to power tech growth.

This article is brought to you courtesy of Eric Dutram.

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