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Recently, Oracle (NYSE:ORCL) announced deals with Microsoft (NASDAQ:MSFT), NetSuite (NYSE:N), (NYSE:CRM), and Deloitte. The deals are meant to improve interoperability of applications, including cloud-based offerings. While some may be surprised by the news, "interoperability" has been a buzz word for years. That said, Oracle disappointed investors when it reported fiscal 2013 earnings; the share price declined substantially as a result.

That may be because Oracle has been losing sales to competitors, based on the analysis of its asset utilization. That being what it is, how should investors think about Oracle following the release of its fiscal 2013 earnings report?

To answer that question, analysis of asset utilization, profitability margins, return on equity and the valuations will be included in this report. Based on my research, Oracle is becoming less efficient and may be losing sales to competitors, but the firm's profitability margins improved. And, Oracle's return on equity is higher than the cost of equity. Thus, given the decline in valuations, investors should increase long exposure to shares of Oracle.

Asset Utilization

Asset utilization ratios measure how well a company manages various activities, particularly how efficiently it manages various assets. These ratios reflect the efficient management of both working capital and longer term assets: Receivables turnover, days of sales outstanding, working capital turnover, and total assets turnover.

Oracle's accounts receivable balance is trending lower. The decline in accounts receivable is probably mostly attributable to the decline in hardware sales. Thus, the improvement in receivables turnover and days of sales outstanding is more likely attributable to Oracle losing sales to competitors than to an improvement in credit collections.

Further, working capital turnover continues to trend lower. The working capital ratio indicates how efficiently the company generates revenue with its working capital. The indicator suggests declining efficiency. That is consistent with the previous interpretation: Oracle is not becoming more efficient; it could be losing sales to competitors.

The total asset turnover ratio measures the company's ability to generate revenue with a given level of assets. Oracle's total asset turnover ratio is trending lower; this indicator suggests Oracle is becoming less efficient.

In summary, Oracle is becoming less efficient and could be losing sales to competitors. The asset utilization indicators are bearish for the valuation of Oracle.

For more information on asset utilization please visit this article.

Profitability Margins

Profitability it one of the most important portions of financial analysis. Investors are generally focused on a company's ability to generate future earnings. Profitability is a component of valuations. In some cases investors are more focused on margins than on valuations. Oracle's operating and net profit margins will be examined.

Fourth quarter revenue came in above my expectations. The operating margin expanded to 46 percent, which is above my forecast . Full-year revenue came in at the mid-point of my expectations. Operating income and net income came in just above my expectations.

The increase in the operating and net profit margin is probably attributable to the revenue mixture. With hardware sales declining, more of total sales came from software. Thus, software sales drove operating margins higher.

Overall, Oracle has high profitability margins. Consequently, the profit margins are bullish for the valuations of Oracle. Further, the margin expansion adds to the bullish case for Oracle. On the bear side, revenue growth slowed substantially this year.

Return on Equity & Valuations

In this section, Oracle's residual income generation will be discussed. The capital asset pricing model is used to estimate the cost of equity. Residual income means the company is generating returns above its cost of equity capital.

To value the common equity shares of Oracle the multiplier model valuations will be used. The absolute levels and the time series trends will be examined. Generally, investors want to pay reasonable prices for future cash flows and be able to realize a significant return on capital in a relatively short period of time. The combination of these valuation models should allow investors to achieve both objectives.

Return on equity increased in 2013 to 25% from 24% in 2012; return on equity bottomed in 2010 at 22%. Oracle's cost of equity is roughly 7%. Thus, Oracle continues to increase shareholder wealth. Further, Oracle should continue to create wealth for shareholders in fiscal 2014, based solely on the cost of equity and return on equity comparison.

In terms of valuation, Oracle is undervalued relative to the industry average valuations and its five-year average valuations. Relative to the S&P 500, Oracle is fairly valued. Lastly, relative to its recent valuations, Oracle is undervalued. Thus, I conclude that shares of Oracle are undervalued.

In summary, Oracle is undervalued and its return on equity is higher than its cost of equity.

For more information on return on equity and cost of equity please visit this article.


Bulls: The residual income is positive, and the share are undervalued. Further, the profitability ratios suggest Oracle has a wide moat, and the operating and net income margins expanded and may continue to expand.

Bear: Oracle is becoming less efficient and may be losing sales to competitors. Further, sales growth slowed; thus, Oracle may command a lower price multiple.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.