Oracle: Why It Is Expected To Trade Higher

Apr. 1.14 | About: Oracle Corporation (ORCL)

Summary

Oracle is making a smooth transition to the SaaS model.

Engineered systems are a value added.

The share price is trending higher.

The share price of Oracle Corporation (NYSE:ORCL) went on to make a higher high following the previous report as software sales continued to trend higher and hardware revenues stabilized. Oracle's share price is likely to continue to trend higher even as the company's growth rate is forecasted to increase at a pace below the long-term growth rate.

The previous report called for a 5-year revenues CAGR of 7%, but the fiscal 2015 revenues forecast is for growth of 4%. Diluted EPS is forecasted to increase 9% in 2015 relative to the 2014 forecast. The forecast assumes continued strong on-premise and SaaS sales as well as the ramping of IaaS and PaaS services. Engineered systems should continue to be a source of strength, as the engineered systems appear to be a value added in the commoditized server/hardware industry. Services may continue to be a drag.

In conclusion, the fundamentals of Oracle remain bullish and the intrinsic value estimate increased to $46.48 per share from $46.16 per share.

Recent Developments

  1. Neiman Marcus Group contracted with Oracle to improve its retail operations.
  2. Oracle introduced Primavera Prime, for project portfolio management, as well as Primavera Prime Capital Plan Management. This is the first Enterprise PPM offering designed to leverage Oracle's Engineered Systems.
  3. Oracle acquired BlueKai, the industry's leading cloud-based big data platform that enables companies to personalize online, offline, and mobile market campaigns with richer and more actionable information about targeted audiences.

Business Summary

Oracle Corporation 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. The company 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 past few fiscal years, Oracle has been using its excess liquidity to make strategic acquisitions in the high-growth rate cloud space. For instance, Oracle acquired Eloqua for B2B marketing exposure and Responsys for B2C marketing exposure. In 2012, the company acquired Taleo, a talent management solutions provider. The transition to cloud-based applications posed a threat to legacy on-premise software vendors; consequently, Oracle needed to react to the new entrants. While it is challenging to fully evaluate the acquisition prices of all of the deals, Oracle appears to be allocating capital to investments that could provide a significant ROI.

For the fiscal year ending (in millions of dollars except per share data):

2010-05

2011-05

2012-05

2013-05

2014-05E

2015-05E

Total revenue

$26,820

$35,622

$37,121

$37,180

$38,427

$39,964

Operating income

$9,062

$12,033

$13,706

$14,684

$14,218

$14,987

Net income

$6,135

$8,547

$9,981

$10,925

$10,760

$11,590

Diluted EPS

$1.21

$1.67

$1.96

$2.26

$2.34

$2.56

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For fiscal 2014, operating income is forecasted to come in slightly below 2013's operating income level as the operating margin contracts; the margin contraction is partly attributable to a one-time gain in fiscal 2013. For fiscal 2015, total revenue is forecasted to increase on higher software and hardware sales, which are likely to be boosted by SaaS and engineered systems. Oracle remains well positioned within the enterprise applications industry.

2010-05

2011-05

2012-05

2013-05

2014-05E

2015-05E

Asset turnover

0.44

0.48

0.47

0.45

0.46

0.46

Ending financial leverage

1.97

1.83

1.78

1.81

1.86

1.86

Debt-to-capital

32%

28%

27%

29%

35%

34%

Total equity Y/Y

23%

29%

10%

2%

-1%

4%

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The total asset turnover ratio has been stable over the past three fiscal years. Financial leverage has generally trended lower, but there was an increase in debt capital during the current fiscal year. Management is expected to retire $1.5B of debt during fiscal 2015. Total equity growth slowed as management returned excess capital to shareholders.

For the fiscal year ending (in millions of dollars):

2010-05

2011-05

2012-05

2013-05

2014-05E

2015-05E

Cash flow from operations

$8,681

$11,214

$13,743

$14,224

$15,371

$17,185

Capex

$230

$345

$648

$650

$620

$675

FCFF

$9,017

$11,475

$13,670

$14,172

$15,439

$17,192

FCFE

$12,089

$12,080

$13,390

$15,598

$20,317

$15,010

Stock repurchased

$992

$1,160

$5,856

$11,021

$13,000

$9,960

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The forecast is for continued strong cash flow growth. Oracle has a small amount of capital expenditure relative to cash flow from operations, which produces a significant amount of free cash flow. Free cash flow to equity is forecasted to increase substantially in fiscal 2014 as management increased net borrowing. During fiscal 2015, $1.5B of debt is forecasted to be repaid, which decreased the amount available for share repurchases.

Oracle's product offerings are strong, with the exception of the services segment. The software segment is the bread-and-butter and the company has made a relatively smooth transition to the SaaS model. The engineered systems are a value-added solution in a commoditized server industry. All of that and more is reflected in the financial performance and position.

Risks

  1. The share price is likely to remain volatile and investors could lose a portion or all of their investment.
  2. Investors should judge the suitability of an investment in ORCL in light of their own unique circumstances.
  3. A decline in the global economic growth rate and/or a decline in the pace of economic growth in the United States could adversely impact the results of operations and the share price.
  4. The technology industry is characterized by rapid technological change, which could materially adversely impact the results of operations.
  5. Competition in product development and pricing could adversely impact performance.
  6. Incorrect forecasts of customer demand could adversely impact the results of operations.
  7. Higher interest rates may reduce demand for ORCL's offerings and negatively impact the results of operations and the share price.

This section does not discuss all risks related to an investment in ORCL.

Portfolio & Valuation

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Oracle is in a bull market of minor, intermediate, and primary degree. The share price is expected to continue making higher highs, but the rally is closer to an end than a beginning. Shares should trade above $40 per share and maybe up to $45 per share. Even higher is possible depending on the fundamentals.

Monthly expected return

Quarterly expected return

Quarterly standard deviation

1.5%

4.4%

13%

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Intrinsic value estimates

Forward price multiples at base case intrinsic value

Optimistic

$58.71

P/E: 18.13

Base case

$46.48

P/S: 5.26

Pessimistic

$34.25

P/BV: 4.50

P/CFO: 12.22

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Based on the fundamentals of the firm, the base case intrinsic value estimate is $46.48 per share. While the forward price multiples, which are based on fiscal 2015's estimates and the base case intrinsic value, are not excessive, the price/sales and price/book value ratios are above the 5-years' average valuation. Nonetheless, the estimates used to derive the intrinsic value are conservative.

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.