Oracle Turnaround Equals Big Opportunity With Less Risk

Alex Cho

Alex Cho

CEO l Research Director

[email protected]

Jason Chen

Jason Chen

COO l Research Editor

[email protected]

Shakeel Stewart

Shakeel Stewart

Columnist and Author

What do you do when you want to remain invested in equities at what you fear to be a market top, but don’t want to risk paying top dollar and suffering in a correction? The market is looking especially inflated for large-cap stocks, especially in the tech sector, where years of out performance have led to inflated multiples and a general sense of invincibility.

Our answer here is to go after stocks that are slightly less splashy, yet still have enough fundamental consistency to avoid any serious negative news flow. One reliable large-cap tech stock that we remain bullish on is Oracle (NYSE:ORCL). Oracle’s heyday is certainly behind it, and both large-cap competitors and newer startups have galloped past Oracle in many areas of cloud software. 

Yet at the same time, the company’s massive built-in customer base, its broad product portfolio that speaks virtually every category in enterprise software, and its long history of minting profits are appealing traits in an expensive stock market, as is the fact that Oracle still trades at slight discounts to the broader market. Over-indexing your portfolio in names like Oracle, in my view, is the best way to beat the market in what we view to be a choppy stretch of trading for the next 6-12 months.

Now, the market has already acknowledged Oracle’s value this year. Its stock is up ~40% year to date, beating the broader market by ~2x – driven by a combination of fundamental outperformance and a catch-up in valuations to peers. In our view, this outperformance trend will only continue. Yet the Oracle rally has taken a breather over the past few months, driven especially by a relatively weak fiscal Q1 earnings performance recently. To us, this stalling in the stock represents a fantastic buying opportunity for Oracle.

The Oracle bullish thesis

Oracle is a company that is so large and varied that it’s difficult to pinpoint exactly what the company does. While Oracle has no consumer products, it is a readily recognizable brand, yet the scope of its products is rather opaque. It can’t exactly be called a database company anymore, because its legacy database offerings have been supplanted by the company’s new suite of cloud apps.

But from an investment standpoint, here are what I view to be the key merits for Oracle:

  • Oracle’s portfolio is broad and covers every spectrum of enterprise technology. Oracle now has a full suite of front-end applications covering functions such as supply chain, finance, HR, sales – everything under the sun. The company has also retained its traditional strength in backend infrastructure, with products like the Oracle Autonomous Database. Not all of Oracle’s products have to be winners: at the moment, cloud apps continue to see 20-30% growth, offsetting declines in legacy segments.
  • Sales machine. Oracle essentially invented the sales playbook in Silicon Valley. Its late co-CEO, Mark Hurd, is often credited with institutionalizing the position of a “business development representative”, the cold-calling army that now represents among the most common entry-level positions in the industry. Oracle has among the best-oiled sales processes in enterprise technology, and continues to leverage that playbook to grow its business.
  • Profitability has long been core to Oracle’s DNA. Oracle has retained enormous profitability, even with its shift to cloud and away from lucrative license/maintenance contracts. Its mid-40s pro forma operating margins are among the highest in the software industry.
  • Recent personnel decisions could boost profitability. More to that point, Oracle’s decision to move its headquarters from Redwood Shores (a small town in the San Francisco Bay Area that is almost exclusively dedicated to Oracle’s headquarters) to Texas could help lower Oracle’s overall personnel costs. It has also announced a flexible remote work policy that is also slated to reduce overhead (Larry Ellison himself has committed to working out of Hawaii for the time being).
  • Big buybacks. Oracle has been a big proponent of utilizing its considerable balance sheet to return capital to shareholders. Over the last ten years, Oracle has managed to bring down its outstanding shares by a considerable 46% (compare that to many newer software startups, which issue new stock like candy and continue to grow at all costs by raising secondaries and using stock to buy out competitors).


Oracle is also one of the few tech companies whose P/E ratios make sense, and they’re reasonable, too.

The company only offered vague guidance for FY22 (the current year ending May 2022); CEO Safra Catz summarized as follows on the Q1 earnings call (key points highlighted):

“I remain highly confident that fiscal year 2022 revenue growth will accelerate because our fast-growing cloud businesses are becoming a larger portion of our total revenue. I see total revenue growth for fiscal year 2022, which is the one we’re in, somewhere in the mid-single digits in constant currency and accelerating. Cloud is fundamentally a more profitable business compared to on-premise. And as we look ahead to next year, we expect company operating margins will be the same or better than pre-pandemic levels.

Wall Street consensus is calling for $4.69 in pro forma EPS this year (flat versus FY21’s $4.67) and $5.14 next year (+10% y/y). This year’s pro forma EPS estimate may prove too bearish if Oracle is anecdotally pointing to revenue acceleration plus “same or better” margins. Still, at these estimates, Oracle’s current ~$90 share price represents:

  • 19.1x P/E vs. FY22 EPS
  • 17.5x P/E vs. FY23 EPS

In other words, the company is still trading at slight discounts to the broader market, making its valuation quite compelling.

Q1 Results

It’s also important to note that what investors punished Oracle for recently (Q1 results) were largely a function of currency movements beyond Oracle’s control. Take a look at the Q1 earnings summary below:

Figure 1. Oracle Q1 results

Oracle Q1 earnings results

Source: Oracle Q1 earnings release

Oracle’s revenue grew 4% y/y to $9.72 billion, slightly missing Wall Street’s expectations of $9.76 billion (by only 30bps of growth), and decelerating versus last quarter’s 7% y/y growth pace. The company notes that it outperformed the midpoint of its constant-currency revenue guidance by $100 million. The strengthening of the dollar over the past quarter, after the company issued guidance for Q1, hurt overall growth.

Cloud results, meanwhile, continued to be strong. As consistent with the past couple of years, Oracle no longer reports its cloud business as a whole anymore, but it does highlight performance for specific products. Netsuite, in particular, the mid-market ERP that Oracle acquired several years ago, is still growing revenue at a 26% y/y pace (not far off from the ~30% pace at which Netsuite was growing when it was acquired), showcasing sustainable momentum for that product. Its Fusion ERP system intended for larger clients, meanwhile, grew 30% y/y while back-office applications grew 25% y/y.

Larry Ellison, Oracle’s founder and now its CTO, commented during the Q&A portion of the earnings call that Oracle’s proficiency across its two cloud ERP products has substantially increased its win rates against the giant in the ERP space, SAP. Ellison’s brief is that SAP’s competing products are “not truly cloud,” and hence Oracle’s continued success in winning new ERP deals. Per his remarks on the call:

“And basically all of the implementation services you see for applications are cloud implementations. We’ve now made the migration and that should just grow steadily as demand for those systems increases.

We really don’t have a lot of competition. That’s the understatement of the year in cloud ERP. I’d love to know who the competitors are. SAP doesn’t have a product. When we – we’re in a competition with SAP right now and we’ve just gotten – we just found out, we’re the vendor of choice and their big thing was SAP doesn’t have a cloud product. They have hosting. They’re willing to put a custom computer in Amazon and just build a specialized version for the customer. That’s not the cloud.

We update our applications every three months, the entire fleet of 8,000 Fusion customers are updated every three months. The entire fleet of 28,000 NetSuite customers are updated every six months. You get SAP, they install it and then they probably will update it again five years from now. It’s an on-premise system. They don’t have a cloud system. We’re winning every deal against them, everyone, and we’re taking a lot of their customers away.”

Oracle also continues to be a profitability giant. Pro forma operating margins remained flat at 45%, while GAAP operating margins boosted one point to 35%. The company has also generated $12.6 billion of free cash flow over the trailing twelve months, up 9% y/y. Pro forma EPS of $1.03 also grew 11% y/y.

Figure 2. Oracle FCF trends

Oracle Free cash flow trends

Source: Oracle Q1 earnings release

Key takeaways

There’s a lot to like about Oracle, especially with the market seemingly trapped in sideways trading at all-time highs. Oracle’s mid-20s growth in its ERP products plus Ellison’s commentary about SAP’s loss of momentum in its traditional stronghold category is promising, as is Oracle’s continued focus on Autonomous Database. Given that Oracle is still trading at a discount to the broader market, we think this is a low-risk stock to bank on.

Disclosure: Cho Research was not compensated by Oracle to publish “Oracle Turnaround Equals Big Opportunity With Less Risk” Though Cho Research does use the research dollars it
generates from other clients of our research service to fund market research
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