The share price of Oracle Corporation (NASDAQ:ORCL) rose by 36.8% after it touched the 52-week low of $25.32 in May 2012. At $34.63, the stock is trading near its 52-week high of $36.31 and offers a 0.7% dividend yield. There are 4 compelling reasons backing my view that Oracle is still poised for a solid upside despite the significant price appreciation.
1. From a relative valuation perspective, Oracle shares are priced favorably based on the company's solid financials relative to its peers (see chart below). Consensus estimates on average predict the firm's revenue, EBITDA, and EPS to grow at 2-year CAGRs of 5.8%, 10.8%, and 11.2%, respectively. Those estimates are notably below the averages of 9.7%, 19.2%, and 23.6%, respectively, for SAP AG (NYSE:SAP), which is Oracle's closest competitor. However, Oracle's long-term EPS growth rate is forecasted to be 12.4%, fairly in line with SAP's estimate at 12.9%. On the profit side, Oracle demonstrates a better performance as the company's various profitability margins and capital return metrics are markedly above SAP's measures. Oracle's leverage is fairly in line with that of SAP given the consistent debt to EBITDA multiple. In terms of liquidity, Oracle possesses a higher free cash flow margin. Both the firm's current and quick ratios are substantially above SAP's level, reflecting a healthy balance sheet condition.
To summarize, Oracle's relatively weaker growth potential would likely be the primary drag on the stock valuation. However, given the firm's superior profitability, robust free cash flow generation, as well as its excellent corporate balance sheet, I believe the stock's fair value should not trade at a large discount to SAP's level. Nevertheless, the current valuations at 7.7x forward EBITDA (next 12 months) and 12.2x forward EPS (next 12 months) together represent an average discount of 32.3% to the same trading multiples of SAP, suggesting that Oracle shares are likely trading at the low end of their fair value range or even modestly undervalued on a relative basis. Further, Oracle's PEG ratio at 0.98x is 26.8% below SAP's PEG at 1.34, reaffirming the attractive valuation level (see chart above).
2. Oracle's forward P/E multiple of 12.2x is currently trading at a 13.5% discount to the same multiple of the S&P 500 Index, which stands at 14.3x now (see chart below).
I believe the stock should reasonably command a market-level valuation provided that 1) Oracle's long-term earnings growth rate of 12.4% is considerably above the average estimate of only 8.2% for the S&P 500 companies; 2) Oracle's financial performance including profitability margins, capital return, and free cash flow generation is significantly above the market average and the firm has been able to sustain and improve the key financial metrics over the last 5 years (see charts below); and 3) the company also possesses a significant market share in the global enterprise software sector.
3. Oracle's consensus EPS estimate has experienced multiple upward revisions over the past 12 months (see chart below). In addition, over the same period, sell-side analysts' average target price has increased from $33.49 to $37.55 and the consensus long-term EPS growth rate has been steadily trending at around 12.4% (see chart below).
4. Sell-side analysts are bullish on the stock. According to Thomson One, of the total 44 ratings, there are 9 strong buys and 22 buys. In a research note dated February 1, 2013, Karl Keirstead at BMO Capital Markets upgraded the stock rating from market perform to outperform based on the following rationale which I tend to agree on (sourced from Thomson One, Equity Research):
"Bottom line, we conclude that enterprise data software spending is improving after a rough 2012 and that demand for engineered data appliances is now broad enough that Exadata sales will have a discernable impact on Oracle's overall growth rate in 2013. Rival SAP appears to be backing off its 2015 database target, Oracle is at least fighting back in the cloud application market, and we believe the worst of the hardware declines are behind us. Coupled with continued margin gains, we believe that the likelihood of EPS upside is high and that at just 13x non-GAAP EPS, Oracle shares represent compelling value even after the recent run from $30 to $35."
In conclusion, investors should consider buying Oracle at the current price in the light of the company's sound fundamentals, promising growth prospects, and cheap valuation.
All charts are created by the author except for the consensus estimate tables, which are sourced from Capital IQ, and all financial data used in the article and the charts is sourced from Capital IQ unless otherwise specified.
Disclosure: I am long ORCL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.