Oracle Corporation (ORCL) is a cyclical company that benefits from expansionary monetary policy. That said, declining hardware sales have been a drag on the consolidated financial performance; the acquisition of Sun Microsystems hasn't worked out well thus far. That said, I believe the hardware offerings provide value to customers and hardware sales will eventually stabilize.
This fiscal year, I am forecasting revenue growth in the 2% to 5% range with EPS growing close to double digits because of the share repurchase program. Historically, Oracle has outperformed the S&P 500, and I think Larry Ellison and the rest of management will figure out how to get the common shares to outperform again.
All of that said, I estimate that Oracle is fairly valued at the current share price. The $27.24 level and below is an accumulation zone.
- Increased competition from rivals reduces Oracle's growth rate and decreases its intrinsic value.
- The Hardware segment continues to be a drag on consolidated financial performance.
- The Services segment becomes more of a drag on financial performance.
- The share repurchase program is moderated in fiscal 2015 and/or 2016.
- The share price is volatile and investors could lose a portion or all of their investment.
- Oracle announced Oracle BI Mobile App Designer, a new design tool with which business users can easily create interactive analytical applications for use on any major mobile device.
- Oracle introduced Oracle Product Lifecycle Management Mobile for Agile.
Oracle is the world's largest provider of enterprise software and a leading provider of computer hardware products and services that are engineered to work together in the cloud and in the data center. Additionally, Oracle is a leader in the core technologies of cloud computing, including database and middleware as well as web-based applications, virtualization, clustering and large-scale systems management.
The company is organized into three business segments: Software, Hardware Systems and Services. Those business segments are further broken down into operating segments. Software is the largest business segment followed by Hardware Systems and Services, which contributed roughly equal shares of fiscal 2013 consolidated revenue. The hardware segment has been a drag on consolidated results of operations, which may continue because of a shift in the mix of hardware offering sales.
The enterprise software and cloud-based computing markets are growing while the hardware market is shrinking. I think hardware sales will continue to slump in fiscal 2014. That said, I think Oracle is well positioned in terms of its hardware offerings; infrastructure-as-a-service could offset some of the declines in traditional hardware sales. Also, Oracle's machines are designed to run Oracle's software, which is a good product differentiation strategy that sets Oracle apart from some rivals including Microsoft.
Oracle faces competition from International Business Machines (IBM), Hewlett-Packard Company (HP), Microsoft (MSFT), SAP AG (SAP), and to a lesser extent smaller companies such as a salesforce.com (CRM), Workday (WDAY), and VMWare (VMW). Due to its scale and ability to integrate hardware and software offerings, Oracle is well positioned in the competitive landscape.
In fiscal 2013, Oracle acquired Acme Packet, a provider of session border control technology. Another notable acquisition was the acquisition of Taleo, a provider of cloud-based talent management solutions, in fiscal 2012.
On June 20, 2013, Oracle announced that the Board of Directors approved a further expansion by $12 billion of the share repurchase program.
Financial Performance Forecast
Oracle reported fiscal 2013 revenue that was within my expectations, but operating income and net income were above my expectations as the margins expanded because Software is a higher margin business than Hardware. In fiscal 2014, I expect revenue growth to resume as Europe emerges from recession.
I'm forecasting fiscal 2014 revenue to increase 2% to 5%; revenue should be between $37.9 billion and $39.04 billion. I think Software and Services should have a solid year and the pace of decline in Hardware should slow. The operating margin should be between 39% and 41% and the net income margin should be between 29% and 31%. Earnings per share should receive a substantial boost because of the smaller quantity of outstanding shares.
I'm forecasting revenue of $8.34 billion in the fiscal first quarter, a 2% increase relative to the year-ago quarter. The operating margin should be 39% and net income margin 29%. I think 4.68 billion shares will be outstanding at the end of the fiscal first quarter, so GAAP EPS should be about $0.51 to $0.52 per share.
Oracle has a rock solid balance sheet, but the firm has been increasing leverage, which could boost returns to shareholders. The unadjusted financial leverage ratio was below 2 at the end of the fiscal 2013 fourth quarter. The asset utilization ratios are excellent, but Oracle sells some of its receivables, which boosts the activity ratios.
I'm going to use multiple models to value the common equity shares of Oracle. I'll use discounted cash flow models, and multiplier models. I estimate the sustainable growth rate of the enterprise application industry at 6 percent, which is above the global economic growth rate. The current share price of Oracle is $32.03.
Using a discounted cash flow model, I estimate the intrinsic value of the common equity shares of Oracle as $30 per share. To be fair, discounted cash flow models are sensitive to changes in the assumptions. I have confidence in my required rate of return, but a change in the growth rate could mean Oracle shares are worth $18.46 per share or $80 (or more) per share. The dividend growth rate has been roughly 20%, but I don't think that is a sustainable growth rate. Thus, I modeled the value using a global economic growth estimate plus a premium for the industry.
Based on my estimates, Oracle is trading at a forward PE of 14.50 and the justified PE is 12.5, which means Oracle is 14% overvalued. Using this method, the intrinsic value is $27.61 per share.
I will also use the historic average multiplier valuations to find the intrinsic value of shares of Oracle. Using the price/earnings ratio, the intrinsic value is $41.64. The intrinsic value using the price/book ratio is $37.85, using the price/sales ratio is $35.15, using the price/cash flow ratio is $39.44. The average of those values and the intrinsic value using this method is $38.52.
I think the multiplier model captures Oracle's historically high growth rate and the justified value captures the slow down in growth recently. The average of all three valuation methods and the intrinsic value of Oracle is $32.04, which is almost exactly what Oracle is trading for at the moment.
With everything presented here taken into consideration, I think $27.24 per share and below is the accumulation zone, which is roughly at the lowest intrinsic value estimate.