Earnings Preview: Oracle

May.30.12 | About: Oracle Corporation (ORCL)

Company Profile

According to Oracle's (NYSE:ORCL) website, "with more than 380,000 customers -- including 100 of the Fortune 100 -- and with deployments across a wide variety of industries in more than 145 countries around the globe, Oracle offers an optimized and fully integrated stack of business hardware and software systems."

Oracle is due to report earnings on Friday, June 8.

Current Analyst Estimates

The consensus analyst estimate is for Oracle to report earnings of $0.78/share, falling midway between the low end of the range at $0.73 and the high end at $0.81. The mean estimate for revenue comes in at $10.9 billion between estimates for revenues as low as $10.7 billion and as high as $11.09 billion. The estimated earnings number, if attained, would represent year-over-year earnings growth of 4%, while the revenue growth, if it comes in at consensus estimates, would represent growth of 0.9% from the same quarter a year ago. Earnings and revenue estimates are derived from the 37 analysts covering the stock.

Consensus Earnings Estimates Trend

Consensus estimates for earnings have held steady at $0.78/share for the past two months. This represents a slight increase to estimates at the start of the quarter, which had the company earning $0.76/share.

Current Analyst Price Targets

The most recent analyst action for Oracle was May 4, when Stifel Nicolaus came out with a buy rating on the stock and a price target of $34/share. A flurry of recommendations also came out in late March, with three firms -- UBS, FBR Capital, and MKM Partners -- all rating the company with a buy rating and $36 price target.

Ratio Analysis

To get a sense of the current valuation with respect to its competitors, below is the ratio analysis for Oracle vs. industry peers Microsoft (NASDAQ:MSFT) and VMware (NYSE:VMW), along with the industry and S&P 500 averages.

ORCL MSFT VMW Industry S&P 500
Price / Earnings 13.93 10.75 51.85 13.2 15.3
PEG 1.17 1.21 2.21 --- ---
Price / Sales 3.56 3.40 10.19 2.7 1.3
Price / Book 3.07 3.62 7.80 3.6 2.2
Dividend Yield 0.91% 2.71% --- 1.7% 2.1%
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Other competitors in the Application Software industry include Citrix Systems (NASDAQ:CTXS) and CA Inc. (NASDAQ:CA).

Fair Value Analysis

The valuation of discounted cash flows is an effective tool in identifying the intrinsic value for well-established companies. The input for the analysis is as follows:

Input
Revenue Growth Rate (Current Year / Ongoing) 3.7% / 6.5%
Cost of Goods Sold (COGS)(% of Revenue) 22%
Operating Expenses (% of Revenue) 42.8%
Tax Rate 25.4%
Weighted Average Cost of Capital 9%
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Technology sector titan Oracle has seen increases in the cost of goods sold (relative to revenues) over four consecutive years. If left untamed, these costs will erode shareholder value in the future. As such, the fair value analysis will consider cost of goods sold of 22% of revenues for the foreseeable future, which is a slight increase year over year. Analysts see revenues increasing 3.7% for the 2012 fiscal year and 6.5% in 2013. To preserve the conservative nature of the fair value approximation, revenue growth will then be presumed to dwindle down to 1% annually.

Over the last five years the company has managed to keep its operating expenses in check, and for that reason the five-year moving average was used while the five-year average between 2007 and 2011 was used for the company's ongoing tax rate. The result from the fair value analysis proves to be slightly below the $36/share target price set by those analysts mentioned above. The approximate fair value obtained using these inputs is $33.55/share, which represents a 27.8% premium to the current market price of $26.27.

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