Motley Fool Hidden Gems Investing - Cisco & Cerebras Orders up, Stocks Down

Starting point is 00:00:00 The wild ups and downs of earnings season continues. Motley Fool Hidden Gems Investing starts now. Welcome to Motley Fool Hidden Gems Investing. I'm your host, Tyler Crow. And today I'm joined by longtime Fool contributors, Jon Quast and Matt Frankel. Guys, it has been a wild up and down of the second quarter. Look, we could go into the several reasons And maybe once the earnings season dies down, we'll really kind of do a postmortem of why this seems to be happening more with the AI trade recently and the volatility of the recent stock market. But we're a little busy with earnings right now. We had a couple of big earnings reports. We had Cisco, we had Cerebros, which is a new IPO, a lot of investor excitement around that.

Starting point is 00:00:46 And then we really dug into some under-the-radar stocks, doing a little bit of a lightning round, letting us kind of indulge our analyst tendencies a little bit here. But let's start with Cisco. Shares of Cisco are down 7.4% as we record. And considering the moves we've seen so far in the second quarter, that's actually a rather mild reaction for the stock. And as with anything that's selling equipment to data centers and AI, sales growth looked great, but it seems as though the fly in the soup was related to like service revenue,

Starting point is 00:01:17 which came in a little lower than expected. So what, Matt, start with you, what stood out in the report? Yeah, so about 85% of the companies in the S&P 500 have beat earnings expectations this quarter. It begs the question, why do we have earnings expectations at this point? But an earnings beat alone isn't enough to move the needle, it seems, this quarter. Even a beaten raise is not enough to move the needle here. Cisco itself has now beaten earnings estimates for the past five quarters in a row. So it's kind of just expected at this point. I mean, the AI story was impressive. The latest guidance,

Starting point is 00:01:49 which was already revised upwards several times, was calling for about $9 billion in AI orders this year. And Cisco produced 9.3 billion. But honestly, that's not as impressive of a beat as we've seen Cisco make in recent quarters. Remember, their original guidance was for 5 billion. They beat that through three quarters. That was an impressive beat. So maybe the market's starting to think that the growth is appropriately priced in. I mean, future revenue growth could be a lot stronger than the numbers suggest. Cisco's product orders in Q4 grew by 35% year over year compared with just an 18% revenue growth rate, that implies we might see an acceleration coming up. Notably though, management didn't provide new guidance for that AI order number. I was certainly looking

Starting point is 00:02:33 for that for the 2027 fiscal year, and I have to believe many investors were as well. Even after today's reaction, Cisco is trading for about 40 times earnings, and it's still within a few percentage points of its all-time high. So it seems like the beaten raise, it just simply didn't live up to expectations, but I mean, all in all, a very solid quarter. Yeah. What decade is it? I mean, Cisco, Cisco, this is incredible revenue growth and it's not just revenue growth that stood out for me, Tyler. It's also the earnings growth. So we did have the 12% top line growth for the whole year, but you look at the earnings per share growth, that's profit minus the share count, right? Divided over the share count, 31% growth for earnings per share. That is a good

Starting point is 00:03:19 sign when earnings per share are growing faster than revenue. And then for the upcoming year, also expecting maybe 16% revenue growth. So a slight acceleration into the coming year, but then also that earnings per share growth, once again, projecting better than 20% growth for the earnings in the upcoming year. So yes, Matt is right. It is trading at a premium valuation at 37 times earnings. That said, the top line growth is great. The profit growth is even better. and the strong demand that it is seeing certainly helps with that profitability. So that's what stood out to me.

Starting point is 00:03:55 For what it's worth, forward estimates have it at about a price to earnings of about 26. But as Matt said, everyone's beating expectations all the time. So maybe that's even sandbagging it a little bit here, doing the dog and pony show of earnings expectations and all that stuff.

Starting point is 00:04:11 Now, look, the stock is down. So I did try to like dig in and be like, well, why is that? everything you guys mentioned all seems pretty good. And something that stood out was remaining performance obligations. I mean, RPOs, if you want to use cool kid jargon, it grew about 7% in the most recent quarter. And compared to other like hardware and software companies, that is rather light. As much as there is demand, and it is incredibly fierce demand, at the same time, competition in this industry is getting stronger, as well as new technologies

Starting point is 00:04:44 are coming out that could somewhat displace a little bit of what Cisco may be doing. So my question to you guys was seeing those RPO numbers, maybe being a little bit more tepid, is this a case where Cisco may be losing shares to the Arista networks or someone else in this industry that I might not be considering here? Well, I think we need to be very careful looking at the percentage numbers when it comes to Cisco, especially in comparison to other companies that are reporting percentages. So you think about Cisco, and the reason I did jokingly say what decade is this is that this is a legacy business. This company has been around a while, already generates more than $60 billion in annual revenue. So this is a very large business, and many of Cisco's customers are more of these legacy customers. And so there is a component here that your remaining performance obligations, if they're being driven by AI, that's going to be somewhat lost in the overall mix of the business because it has so many legacy customers, whereas maybe a more pure play competitor isn't going to experience that.

Starting point is 00:05:56 So the percentage numbers are going to look a lot different. I think we need to be careful from drawing too many conclusions with that. And if we can just zoom out, I think from a hidden gems investing perspective, we are looking for not necessarily a hidden company, but something hidden in the business analytics that maybe people are overlooking for this reason or the other, that we're looking for something hidden that will contribute to a stock performing well over time. I want to give Dell as an example here. Just a couple of years ago, Dell's AI server numbers were just a very small percentage

Starting point is 00:06:34 of the business, but they were really starting to uptick really rapidly. And you could kind of start seeing that, hey, Dell is this huge legacy business, but all of a sudden becoming an AI player. Now that stock is up nearly 800% in just three years, but some of the signs were there earlier for those who are going to dig beneath the surface. And I think that that, generally speaking, can be the case. When you see a legacy business that's all of a sudden benefiting from some booming industry, it might be getting lost.

Starting point is 00:07:06 Those numbers, that narrative might be getting lost in the mix. And so taking some time, digging deeper beneath the surface can sometimes yield something really important from a hidden gems perspective. And I'd say for Cisco, don't dismiss it. We are looking at AI infrastructure orders up nearly 400% year over year, and it's fiscal 2026, looking for nearly 90% growth in those AI infrastructure orders in the coming year. So that is hidden beneath the surface, and it's worth paying attention to. So to unpack your question a little bit more, Tyler, Cisco was losing to Arista at first,

Starting point is 00:07:41 when the AI boom first came up. Then they made a really smart decision to unbundle their full hardware stack, meaning that Cisco chips could be installed in devices they didn't make. that really helped them gain ground. You're right. The RPO looks light, but Cisco's RPO is majority made up of software renewals, the legacy business John was talking about. As John said, for now, AI is just a small percentage of what it does. The order book grew sharply, as I mentioned, 35% year over year. And that doesn't show up mostly in the RPO numbers because Cisco is shipping these products honestly too quick for them to just sit on the backlog. Arista is growing

Starting point is 00:08:18 faster than Cisco right now, if you look at just the top line. But it's really a case of like pure play versus conglomerate. It'd be like comparing Berkshire Hathaway to a pure play energy company when you're looking at energy growth. The company's order book shows that it is still gaining AI traction, as John just mentioned. Cisco, their blended growth looks slower for sure. But right now, the rising tide is lifting all ships in AI networking. Well, hopefully we'll have a repeat performance from Cisco that we saw from the Dell over the past three years. It's certainly trending that way with the stock up 62% over the past year. So maybe 7% seems pretty small pennies by comparison.

Starting point is 00:09:00 Coming up for the break, we're going to look into Cerebrus' earnings. AI risk isn't always easy to see. unapproved tools agents with too much access unmanaged ai exposure isn't just a threat it's untenable but with the right security partner you can prioritize risk and take control get the context you need to take action and reduce your exposure take your ai risk from untenable to tenable tenable your exposure ends here learn more at tenable.com new from Nespresso blend wellness into your coffee routine with the coffee plus range infused with functional benefits choose the coffee you love with added b vitamins like coffee plus

Starting point is 00:09:50 b12 to help support immune function and coffee plus b6 to keep your day moving or go with the flow and choose ginseng delight our new double espresso with ginseng extract whatever lies ahead don't change your morning let your morning change you discover coffee plus on nespresso.com so i got to admit uh in between segments i realized i made a bit of a mistake uh it is not cerebrus apparently uh i stay working from home way too much and don't get out and hear other people talking cerebrus systems is the company we're going to be talking about that's what i get for not listening on the conference calls again so everyone can make fun of me in the comments for mispronouncing this company's name. Makes me look like I don't know

Starting point is 00:10:33 what I'm talking about, but oh well, we're going to do it anyways. So the funny thing is here is this is a company, it's gotten a lot of Wall Street and investor buzz, and it's not having a great day on Wall Street. Company reported earnings that were after the close yesterday, and the stock's down about 13% as we're taping. So this is a novel concept for computing and inference that recently went public. Guys, what did Cerebras' systems report say and what were your reactions? Well, look, Tyler, everything about this company is confusing from what it does to how it reports its numbers, apparently to how its name is pronounced. I mean, investors can be forgiven here if they needed a minute just to take some time and process what this report was all

Starting point is 00:11:18 about. Yeah. So, I mean, at the core, the idea behind this business is simple, right? They build larger chips than any of the other ones that essentially take the place of several NVIDIA chips and other components being networked together. So that's the idea. And it would take less power, lower latency, things like that. The two revenue numbers in the report are uniquely confusing. They report gap revenue, which is what we all expect. And then a number called core revenue, which is actually not only different, but higher. So that could be confusing to investors. So gap revenue grew 74%, but that missed estimates. So reverse is core revenue more than doubled and beat management's own guidance. Now their core revenue,

Starting point is 00:12:00 it excludes the impact of warrants that the company issues to some of its largest customers, specifically open AI. So accounting rules say that you have to account for the value of those warrants and subtract them from your revenue. It's not really a revenue hit, which is why they choose to report core revenue but it's confusing um the during the quarter the revenue mix shifted toward cloud revenue away from hardware uh driven by its open ai deployments uh while hardware revenue actually fell by 23 so that could right there tell you why the stock fell um their core gross margins because of that fell or because of some other factors fell by nearly six percentage points uh it's temporarily renting back some of the hardware previously sold um so management said

Starting point is 00:12:44 Q3 should be the low point for margins and it should come up. But with a money losing business that a lot of people don't really understand the accounting behind and things like that, it just adds to the confusion. Cerebrus' bull case is it's got over a $25 billion backlog. It has nearly $9 billion of cash on its balance sheet. And management specifically said, and I'm quoting, that AI demand is through the roof and revenue will triple year over year in 2027. But I mean, this is a business that investors understandably simply seem to be having a tough time wrapping their heads around. And I really don't blame them. With a revenue miss, margin issues, and a net loss that was surprisingly not great. I'm not terribly surprised

Starting point is 00:13:27 that the stock fell in reaction to this quarter's report. Yeah. You look at the guidance, and I do want to just correct the record here from some of the chatter I've seen on social media. Some investors out there saying, oh, Cerebrus is intending to 10x its revenue in the coming year. That is not what the company said. Matt pointed out the correct number. It expects to triple its revenue year over year in the coming year, which would be absolutely incredible. And I wish them well. But the 10x number, that is for the manufacturing. And so this is a fabless semiconductor company, which means that it doesn't make its own stuff. That is made by other companies specifically taiwan semiconductor is a supplier here and so that 10x number is from

Starting point is 00:14:14 its partners saying that they're going to increase the manufacturing and so you look at taiwan semi it's a pretty conservative company so i do think that in a way this is a vote of confidence to dedicate some energy to making sure that it can 10x the supply of cerebrus's products so um but I do want to point out the difference here. The revenue, and we're talking core revenue, not actual revenue, the core revenue looking to triple, but the manufacturing looking to 10x there's going to be, then that is a huge expected increase of revenue ongoing beyond the coming year. John, I'm shocked, shocked to discover that things that are said on social media aren't

Starting point is 00:14:54 necessarily correct. Look, Cerebrus hits at one of the challenges that I have been struggling with to work through with all of this AI spending, AI infrastructure, build out stuff. You know, it claims its AI chips, which, you know, look closer to the size of the bathroom floor tiles than what we would normally see in CPUs or GPOs. They claim they're faster. They have higher chip on chip memory. They require less power than current offerings. If it is as powerful as it claims, whether that's true or not, it remains to be seen. It would, in theory, solve a lot of the problems we see with memory and electricity demand because we can do more with less. And one of the things I've always said is with the current spending and the trajectory of what we have with the equipment we have, it's not going to work because it just will take too much power, basically. So with me, to me, this seems to undermine the case for some of the biggest winners so far, like NVIDIA, some of the membership members. And we can even go further down the AI infrastructure chain of like, maybe we just need a couple fewer data centers off the line here. Do you agree with this or am I perhaps reading it wrong?

Starting point is 00:15:53 It certainly feels like Cerebrus doing more with less should hurt NVIDIA and the memory companies and the other chip makers. But I mean, so far in this cycle of AI adoption, every single efficiency gain we've seen has just kind of expanded the appetite overall. In other words, right now there's so much demand that both Cerebrus and NVIDIA can grow exponentially. NVIDIA might be, you know, nearing the end of its exponential growth because its revenue is, you know, more than Walmart.

Starting point is 00:16:23 not really but getting close um but right now you know cheaper ai has meant more ai not less and the disruption is real but i mean the fact that cerebrus is relatively tiny compared to nvidia and and has some margin issues of its own and you know production issues and ramp up issues it really shows nvidia's moat right now so i don't think nvidia should be too worried for the time being and nvidia is not exactly just kind of you know laying down and letting themselves be disrupted they have a much deeper pockets than even cerebrus for for uh innovation so i don't think they should be too worried i don't think it's as simple as saying nvidia versus cerebrus i think the answer is much more complicated and nuanced than that because of how these

Starting point is 00:17:09 ai products are they how they actually work in the real world so nvidia of course with its graphics processing units, GPUs. By the way, NVIDIA didn't invent those for AI. They pre-exist the current boom in AI. The reason that they were adopted into AI, specifically training, was because they were very good at general purpose activities. And what Cerebrus is building is an ASIC. This is a custom thing. This is very good at a specialized specialized activity and specifically inference, but for specific configurations. So this is why it's partnered with OpenAI, for example, so that OpenAI can partner with Cerebrus for certain configurations for its custom hardware option. You look at that, you're basically answering a

Starting point is 00:18:06 question between generalization and specialization. Is the specialized, is all of the AI out there going to start specializing and that is going to give greater rise to a player such as Cerebrus or are all of these software products out there going to stay more general purpose in which case that favors a more general hardware option I don't know if that's an easy question to answer I think that the my answer is probably both I think that you're going to see a rise generally speaking and that's going to be good for GPUs but I do think that you're going to start seeing some specialization and that's going to give rise to some niche markets that Cerebras can fill, the question then becomes, how big are those niches?

Starting point is 00:18:50 It's certainly going to be the battle of the AI data center space over the next couple of years as these models become more powerful and more stuff is custom built for these models. So coming up after the break, we're going to indulge our analyst tendencies a little bit and do a lightning round of earnings so far this quarter. new from Nespresso blend wellness into your coffee routine with a coffee plus range infused with functional benefits choose the coffee you love with added b vitamins like coffee plus b12 to help support immune function and coffee plus b6 to keep your day moving or go with the flow and choose ginseng delight our new double espresso with ginseng extract whatever lies ahead

Starting point is 00:19:35 don't change your morning let your morning change you discover coffee plus on nespresso.com stop wasting your nights on a mattress that doesn't get you experience the most comfortable mattress in the world the sleep number smart bed at the touch of a button you can personalize your comfort choose firmer or softer adjust cooler to warmer and right now save up to twenty five hundred dollars during our massive labor day event hurry into your local sleep number store today because we have your number john in our first segment you were mentioning you know the hidden gems being like the hidden assets of companies and part of like hidden gems investing style is isn't just obscure companies

Starting point is 00:20:23 but there is also the hidden aspect where it is you know hidden companies maybe off not the companies most people would think of. So we've been getting a lot of feedback from listeners that we should probably indulge that classical hidden gems sort of part of the phrase and indulge a little bit more here. So, you know, we're going to do basically the stock market equivalent of some deep cut or live album indie band sort of stuff for this lightning round here. Earnings are starting to wind down. And so we're doing a lightning round of under the radar earnings reports. The companies that we love, we don't get to talk much about. So guys, you get to go full stock market sicko here. What do you want to highlight? John, we'll start with you.

Starting point is 00:21:03 Yeah, I love highlighting Xometry. Anytime I get a chance, that is ticker symbol XMTR. This is a company that I was fortunate enough to find when it was trading down in the teens, now up in the 90s. But this is a company for most people who don't know what this company does. Think of all your custom manufacturing that exists in the world. Most of that is offline. Most of that, you need to be kind of close to a shop. You need to email them to come up with, you know, if you need something made, manufactured, you need some bolts made, whatever. You have to then talk to them on email maybe, or just go into the shop and it's got to kind of be close to where you need the product. Xometry changes that by creating basically the e-commerce of custom manufacturing. And what its secret sauce is, is basically you submit your plans through the Xometry portal, and it is able to give you through AI instant pricing. So it prices the job instantly and you

Starting point is 00:21:59 can take it or leave it. Lead times are cut drastically down. And then it shops out its bid to these custom manufacturers who can actually do the work. And it shops it out at a slightly different price. The spread is what its revenue, what its profit is. And so it's not ever going to be a great gross margin business necessarily, but the revenue growth in the case for this, I think, is huge. And the top line growth is showing up 41% in the most recent quarter. That was last week that it reported.

Starting point is 00:22:32 It has reported four straight quarters of accelerating growth right now. One of the things that attracted me to Xometry early on, it's not the first company to try this, but the user growth has been just fantastic. Active buyers on the platform up 20% in the most recent quarter, record new addition. So the adoption curve is what showed me that this could be a winner long-term. Still less than 1% penetrated into its total addressable market. But what I think could be huge here is it just partnered with Siemens. This is a company that helps automakers and airlines kind of start to plan out their products and draw it all up, design the products that they need. Integration with Xometry now kind of helps them have pricing

Starting point is 00:23:17 in real time. And then when they get everything just the way that they want, they can basically hit a buy button. And now all of a sudden that is being shopped out on the Xometry platform. I think that this could be a huge, huge adoption driver long-term. And so Xometry is a company that i'm happy to highlight here yeah i wanted to bring up a fintech company surprise surprise that i haven't talked about in a while it's called marketa ticker symbol is mq they're known for providing kind of third-party payment infrastructure for other companies most notably their biggest customer is block they provide the card payment infrastructure for cash app that makes up a little over 41 of their revenue but that's down significantly it was 46 a year ago was the

Starting point is 00:23:58 majority of their income a couple of years ago. So they got some much needed diversification. And I really wanted to highlight this one because it feels like they've turned a corner profitability-wise. Total payment volume of $120 billion. That was up 32% year over year, the fourth straight quarter where that growth rate was above 30%. And not just that, they actually had positive net income on a gap basis, not just on an adjusted basis or something like that. The second quarter, since they've turned profitable, adjusted EBITDA margin is now at 21% and climbing. They're buying back shares because they think it's cheap. Now, Marquette has had its struggles. It actually did a reverse split not that long ago because

Starting point is 00:24:36 it had been beaten down. This was a COVID era IPO. The stock was down on this report due to a decelerating growth forecast. A lot of that's because Cash App is not an accelerating source of growth for them anymore. It's very cheaply valued on a price to sales ratio historically for this stock. The question is long-term, can it keep those growth rates up while diversifying away from block? That remains to be seen. That's why it's cheap, but it's one that's definitely back on my radar right now. Well, I went through my Rolodex trying to find the obscure stock I wanted to go through, and I saw that BBB Foods, ticker TBBB, reported today, and the stock's up 15%. So I was like, oh, well, I just got to cover this one. So we saw, for those who may have not

Starting point is 00:25:19 have heard this company. It is a hard discount grocery retailer. So think like Aldi, maybe Lidl if you live in Europe, kind of that no frills, not a lot of like decoration, just moving product as quickly as you can at relatively low prices. And this company is completely based in Mexico, has about 3000 stores. So for the quarter, sales were up 38.7% year over year and same store sale growth, you know, comps basically at the existing stores was up 20%, which I think was absolutely I haven't seen a lot of retailers these days putting up same-store sale numbers like that. Store count growth was about 9%. They added about 125 new locations in the quarter.

Starting point is 00:25:57 Puts them on pace for about $500, $50, $600 they want to put in this year. It sounds like a lot, but with $3,200 so far, they're aiming for like $14,000 total all across Mexico. So there's a lot left to growth there. And what was surprising to me, again, they're growing really fast. And despite the high investment levels, they're generating free cash flow, basically because they're moving products so quickly again those rapid same-store sales growth they're generating free cash flow it's just the turn the turnover of this company has been absolutely incredible

Starting point is 00:26:25 generating immense amounts of free cash for what is a relatively small startup mexican grocery retailer i fell in love with this company right when i read the ipo perspectives a couple years ago bought shares and i've been delighted with this success so far hopefully and we can make this is a tradition of every earnings report. We get to indulge in the obscure stocks that we love to follow every once in a while and hopefully the listeners enjoyed it as well. But that is all the time we have for today. Matt, John, thanks for your insights. I'm going to hit the disclosure and we'll get out of here. As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have recommendations for or against. So don't buy

Starting point is 00:27:01 or sell stocks based solely on what you hear. All personal finance content follows Motley Fool editorial standards and is not approved by advertisers. Advertisements are sponsored your content and provide for informational purposes only. To see our full advertising exposure, please check out our show notes. Thanks to producer Art Shannon and the rest of the Motley Fool team, or John, Matt, and myself. Thanks for listening, and we'll chat again soon.

Motley Fool Hidden Gems Investing - Cisco & Cerebras Orders up, Stocks Down

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