Cisco Systems (CSCO) reported earnings about a week ago, and although the company beat analysts expectations for sales and profits the stock has fallen about 5% over the last week. There is no doubt that the recession has been hard on the world’s largest producer of computer networking equipment, as enterprise customers have been unwilling to increase spending on network infrastructure during the tough times. According to management’s statements last week, the tide may be turning thanks to the stabilization of the global economy.

The company reported sales of $8.54 billion in the fiscal 4Q, which was just a shade better than the estimates. Unfortunately sales are still down 17% from a year ago; however, this is the first sequential revenue gains in more than a year. Cisco has combated the declining sales by cutting expenses and headcount. Cutting costs has enabled Cisco to grow their profit margins, as gross margins improved to 65.3% from 64.9% a year ago. Analysts were expecting to see around 64%, so the actual results were quite a bit better.

CSCO Recently, it has been pretty common for Cisco to beat expectations. Going back quarterly as far as five years ago, Cisco has beaten the consensus estimates every single quarter. They do not always outperform by a huge margin, but it does seem that analysts have been just a bit too cautious on CSCO. According to Yahoo! finance, of the 28 analysts that currently cover the stock, 21 of them have raised their estimates for the 1Q in the past month and 23 analysts have increased estimates for full fiscal 2010. This seems to support management’s assertions that the operating environment is improving.

Quarterly trends in sales are finally starting to turn the corner, but CEO John Chambers reiterated that they still expect to see revenue down about 15% for fiscal 2010. It is always a concern to recommend a stock that is losing sales, but we think that at these price levels Cisco is an attractive holding for long term investors. The company has an outstanding balance sheet with more than $35 billion in cash and short term equivalents, nearly $7 per share. The company is expecting to generate more than $7 billion in free cash flow in the coming year, which in addition to their large cash balance will give the company flexibility.

We have been positive on Cisco for sometime and we are reaffirming our Undervalued rating on CSCO, because according to our methodology, the fundamentals have been strong enough to support the lowered price. For Cisco, there has not been a catalyst to inspire investors over the last 18 months, but perhaps the improving sales environment and better margins will start to attract interest. According to our partners at the Motley Fool, crowd sentiment has come around on Cisco recently as the CAPS data suggests investments in CSCO will outperform the S&P 500 going forward. For further evidence, see below as Mad Money Jim Cramer calls Cisco the backbone of the mobile internet revolution.

“My friend Doug Kass who writes with me at, part of, he told me Cisco had a bad quarter. Hey, Dougie, sorry, that was a good quarter. Second, an integral part of the mobile net tsunami, would say the backbone, maybe the spinal column, is Cisco, but you’ve got to have others. Other infrastructure players. And even though I own Cisco for charitable trust, the speculative plays really intrigue because they could have huge moves.” –CNBC’s Mad Money 8/11/2009

Cisco Sees Their Fortune Turning