Over the past year or so, technology stocks have experienced tremendous selling pressure, with the tech-heavy QQQ ETF (QQQ) down ~28% from its highs set in early 2022. Now, despite undergoing a significant drawdown itself, Oracle (NYSE:ORCL) has emerged as a relative outperformer in recent months on the back of robust financial performance.
As you may know, Oracle offers integrated application suites and database software across on-premise and cloud environments, along with secure & autonomous infrastructure via Oracle Cloud, primarily to enterprise customers. Amid a weakening macroeconomic environment, enterprise IT spending is starting to come under considerable pressure; however, Oracle’s cloud business (and M&A activity) has enabled it to grow at a healthy clip in recent quarters.
In this note, we will take a look at Oracle’s pre-earnings estimates and actual performance in Q3 FY2023. Additionally, we will look at key business metrics for ORCL and review its valuation, technical chart, and quant factor grades to see if it is a good buy at current levels.
What Were Oracle’s Expected Earnings? Did It Beat Estimates?
Heading into FQ3 2023 (February 2023) earnings report, Oracle was expected to post revenues and Normalized EPS of $12.43B and $1.20, respectively. And as you can see below, ORCL beat on bottom-line estimates (adj. EPS: $1.22 vs $1.20) but missed (ever so slightly) on top-line numbers (revenue: $12.40B vs $12.43B). While the quantum of revenue miss is minimal, I think the market was quite surprised by the miss as evidenced by a ~5% post-ER drop in ORCL stock.
And there’s a good reason for Mr. Market to be surprised by Oracle’s revenue miss with the emerging Cloud giant’s history of consistently outperforming financial expectations over the past several quarters.
To learn more about Oracle’s revenue miss and key business drivers, let’s dig a little deeper into its quarterly results.
Oracle Stock Key Metrics
In constant currency, Oracle’s quarterly revenues grew by 21% y/y in Q3 FY2023 (18% y/y in USD) on the back of hypergrowth in both segments of Oracle’s Cloud business [Applications & Infrastructure], which is now running at an ARR of $16B+.
Oracle Cloud is gaining traction among enterprises, and the Uber partnership (announced in February 2023) has been widely lauded as a landmark win for Oracle Cloud Infrastructure. On the earnings call, Oracle’s management expressed confidence in winning more such deals:
Customers are putting Oracle’s comprehensive and powerful ways to accelerate their businesses. The Uber win was notable because we have yet another example of an industry-transforming company concluding that Oracle’s cloud, performance and security exceeds that of our competitors and at a price point that represents a sustainable long-term partnership. Uber will use more of our technology to drive value in their own business. And you’re going to see a rising list of these types of strategic wins pile up in the quarters to come.
– Safra Catz, Oracle’s CEO
As of now, Oracle’s Cloud business operates on a much smaller scale compared to hyperscalers such as Amazon AWS (AMZN), Microsoft Azure (MSFT), and Alphabet GCP (GOOGL)(GOOG); however, OCI is showing no signs of a slowdown seen at its peers recently. Clearly, Oracle Cloud’s market share is expanding, and here’s what, Oracle’s CTO (and Founder), Larry Ellison had to say about this matter:
While the momentum in Oracle’s Cloud business looks super impressive with cloud revenues (IaaS + SaaS) growing 45% y/y to $4.1B, these numbers have been boosted by the Cerner acquisition. Excluding Cerner, Oracle’s Cloud business would have grown by 28% y/y to $3.5B, which is a healthy growth rate but it’s nothing explosive relative to the Cloud market.
As of 2022, Oracle had a paltry ~2% market share in Cloud. However, I think Oracle Cloud will be a multi-year secular growth driver for the company in this decade. In future quarters, I will be following the progress of Oracle’s Cloud closely to see if the numbers match up to management’s bullish view of their Cloud offerings.
Now, let’s look at other business segments at Oracle. In Q3 FY2023, the strength in Oracle Cloud was partially offset by a poor performance from its on-premise business. The transition from upfront license revenues to cloud subscription revenues is driving some of this weakness, and as you may know, Oracle is facing weaker IT demand due to a poor macroeconomic environment.
For Q3 FY2023, Oracle reported total revenues of $12.4B. While this figure fell short of analyst estimates for this quarter, Oracle is well on track to hit the $50B milestone for this fiscal year. On the earnings call, Oracle’s management alluded to the strength of their Cloud offerings while painting a positive view of ORCL’s future. Due to low organic revenue growth of ~3.5% y/y in Q3, I am not as excited as Oracle’s management about this business. However, I will continue to closely monitor upcoming quarterly results to see if the positive management commentary translates into better financial performance.
Historically, Oracle has been one of the most profitable software companies on the planet. However, in the last couple of years or so, Oracle’s aggressive cloud push (heightened CAPEX spend) has led to a compression in profit margins and free cash flow generation.
As you can see above, Oracle’s TTM Operating Cash Flows grew by 49% y/y to $15.5B; however, TTM Capital Expenditures grew by 116% y/y to $8.2B, resulting in Oracle’s TTM FCF coming in at $7.3B (up 11% y/y) in Q3 FY2023.
Over the years, Oracle has been a reliable free cash flow machine; however, the company’s aggressive move into the cloud business and strategic M&A in search of revenue growth have led to a drastic drop in Oracle’s FCF in the last couple of years or so.
Back in 2018, Oracle had a robust balance sheet with a positive net cash position. However, management’s aggressive stock buybacks and M&A deals have left the company with a massive debt load of $92B (net debt of $83B).
In fact, Oracle’s current ratio has fallen below 1, which means the company’s current assets do not cover its current liabilities. As of Q3, Oracle’s near-term liquidity situation looks poor. While Oracle is running a slightly negative $2B shareholder deficit (i.e., tangible book value), I do not view the ~$70B of Goodwill and Intangible assets on Oracle’s balance sheet as a realizable amount. And this is why I think investors need to factor Oracle’s debt load into their intrinsic value calculations.
Despite a reduction in its free cash flow generation, Oracle maintained its quarterly dividend throughout 2022 at $0.32 per share. And Oracle’s BOD announced a 25% dividend hike with the latest quarterly report. With this bump, Oracle’s shareholders will now receive a quarterly dividend of $0.40 per share and based on my analysis of Oracle’s Q3 report and management’s commentary, I think ORCL’s dividend is safe.
That said, Oracle’s stock buybacks have shrunk significantly in recent quarters. And considering Oracle’s free cash flows and balance sheet status, I do not expect the company to execute “aggressive” stock repurchases for the foreseeable future despite having ~$8.3B available in its stock repurchase program.
According to consensus analyst estimates, Oracle is set to record ~$50B in revenue for this fiscal year (Q4 FY2023 included) and then deliver high-single-digit CAGR revenue growth over the next couple of four years, with earnings growth projected to outpace revenue growth.
In my view, Oracle is a fundamentally-sound company that is set to grow revenues and earnings steadily over the coming years. Barring its balance sheet, Oracle looks good from a fundamental perspective. Given its high quality, I would be a buyer of Oracle’s stock if it ticks other boxes in our Quantamental Analysis process, i.e., technicals, quant factor grades, and valuation. Let’s run Oracle through the rest of this process now.
ORCL’s Technical Chart & Quant Factor Grades
In the aftermath of reporting a mixed quarterly report, Oracle’s stock plunged by roughly 5% in the post-ER after-hours session last week. While Oracle’s stock has recovered half of these losses since then, ORCL seems to have broken below the lower end of the box pattern it has traded in for the last several weeks.
If ORCL fails to get back above the $86 level in quick order and sustain above those levels, I think Oracle could be headed below $80. With a slowdown in IT spending set to hurt Oracle’s financial performance in coming quarters, ORCL could be headed down to the $65-80 range in the near term.
Technically, Oracle’s stock chart looks precarious. With the stock seemingly losing a key technical level, I would avoid any short-term positions in Oracle for the time being.
After the recent run-up in Oracle’s stock, its Momentum factor grade has improved from “B+” to “A-” over the last six months. Generally, an improving “Momentum” factor grade is a potential sign of a turnaround in the stock. However, Oracle’s stock appears to have run already, and as I see it, ORCL’s momentum grade may shift down as the technical breakdown plays out.
While Oracle’s “Profitability” factor grade has held up firmly at “A+”, “Growth” and “Revisions” grades have deteriorated to “D+” and “C-“, respectively. As I see it, Oracle’s stock could ride the momentum train higher for a little bit longer if it can break back above the $86 level. That said, Oracle’s Valuation factor grade of “F” indicates that it is overvalued relative to its peers. Overall, Oracle is rated a ‘Hold’ [3.44/5] by SA’s Quant Rating system.
Is Oracle Stock A Buy, Sell or Hold?
To answer this question, we will run Oracle through TQI Valuation Model.
Here are my fair value and expected return estimates for Oracle:
Based on my DCF model, Oracle is worth ~$245B. Now, Oracle’s current fully-diluted market cap is ~$235B, which makes ORCL appear to be undervalued. However, Oracle’s massive $92B debt load means that its enterprise value is far greater than its market cap! On subtracting Oracle’s net financial debt of $83B from my intrinsic value estimate of $245B, I get a final fair value of $162B (or $58.27 per share) for Oracle. Hence, Oracle is overvalued by 44%.
Now, let’s take a look at Oracle’s expected returns:
Assuming a conservative exit multiple of ~20x P/FCF, Oracle’s stock could be trading at $186.53 per share by 2028, which translates into a 5-yr CAGR return of ~17.30% from here. In this calculation, I haven’t factored in the debt; however, if we were to subtract the net debt from the target market cap, Oracle’s stock will be worth ~$155 per share in 2028. And in this scenario, Oracle’s 5-yr expected CAGR falls to 13.1% (which is below our investment hurdle rate of 15%). Considering the risk/reward on offer, I do not view Oracle as a “Buy” at current levels.
After a significant run-up in its stock since early October, Oracle is at the risk of breaking down from its box pattern discussed in this note. With Oracle’s Q3 report disappointing on the revenue front amid a pullback in enterprise IT spending, I am not excited at the prospect of investing new capital in Oracle at an elevated valuation.
At ~$84 per share, Oracle currently boasts a market capitalization of about $235B. If we add ORCL’s net financial debt of $83B, we get to an enterprise value of $318B for Oracle. Assuming an annual FCF of $10B (Oracle produced only ~$7B in TTM FCF), ORCL is trading at an elevated EV/FCF multiple of ~32x. With Oracle Cloud gaining traction, I could see Oracle delivering healthy high-single-digit CAGR sales growth (and even faster earnings growth) over the next five years. While I am bullish on its business, Oracle fails to meet my required IRR (investment hurdle rate). Due to a frothy valuation, I rate Oracle “Neutral/Hold/Avoid” at $84.
Key Takeaway: I rate Oracle “Neutral/Hold/Avoid” at $84.
Thanks for reading, and happy investing! Please share your thoughts, questions, and/or concerns in the comments section below.