Oracle: High Expectations... Perhaps Too High

| About: Oracle Corporation (ORCL)
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Oracle (NYSE:ORCL) has such a reputation for being a well-managed company that delivers steady growth that one quarter of missed earnings causes a mini panic.

When the company announced its fiscal third quarter results in mid March, it reported revenue that missed the estimates of analysts polled by Thomson Reuters by 4%. Its earnings per share missed by a penny.

Within minutes, Oracle's shares declined 8% to under $33 a share. It's now trading at just over $32. A year ago, the stock fell from $30 to $25, but it had been increasing in value and hit a 52-week high on March 15 of $36.43, six days before the negative earnings reaction.

Oracle Corp. develops, manufactures, markets, hosts, and supports database and middleware software, applications software, and hardware systems. It has a market cap of $169.3 billion and sells at a price-to-earnings ratio of 14.9.

Earnings Report

Its fiscal third quarter revenue was $9 billion, down 1%. Net income was unchanged at $2.5 billion and earnings per share increased 6% to $0.52. Operating income was up 1% to $3.3 billion, and the operating margin was 37%. Operating cash flow increased to $13.7 billion and free cash flow grew to $13 billion, both third-quarter records.

For the first nine months of the year, Oracle generated revenues of $26.2 billion. The company earned $7.1 billion over the time period, or $1.46 per diluted share. At this rate, the company is on track to generate annual revenues of approximately $37 billion. The company could earn around $10.5 billion for the year.

Oracle has three major operating segments: software, hardware and service. In its earnings report, new software licenses and cloud software subscriptions revenues fell by 2% to $2.3 billion. Software license updates and product support revenues increased 7% to $4.3 billion. Hardware systems products revenues dropped 23% to $671 million.

Between 2009 and 2012, software revenue increased at an annual pace of 11 percent. Hardware systems revenue declined 9 percent in 2012 compared to 2011. Service revenue increased 1 percent in 2012.

The software segment is the cornerstone and strength of the business. Oracle is trying to develop the hardware segment, but has struggled. The services segment is the most stable segment.

Stable Growth History

Overall, Oracle has a stable history of growth. Since 2003, operating earnings have grown steadily by 17% a year. Dividend growth has equaled earnings increases since the first dividend was instituted in 2005.

The company's sales have grown 12.73% over the last five years. Oracle has a five-year average gross margin of 79.30% and net profit margin of 24.6%.

The company's balance sheet shows $15 billion in cash. It has excellent liquidity ratios, with a quick ratio of 3.1 and a current ratio of 3.3. That means it has three times the short-term assets needed to pay off its current liabilities. Its debt level is less than half of its total equity.

The company paid an annual dividend of $0.24 a share, currently yielding 0.8%. It is paying out a relatively low 17% of earnings back to shareholders.

Industry Comparison

Oracle is superior to its industry competitors by most measures. It is more fairly valued, with a P/E of 14.90 compared with the industry average of 20. Its three-year revenue growth of 16.9% is more than double the industry average of 8.2%. Oracle's operating margin (38.3%) and net margin (28.4%) are slightly better than the industry averages of 36.6% and 28.3%.

On the flip side, the company's management effectiveness ratios trail the industry over the last five years. Its annual average return on assets over the last five years has been 11.6%, compared with an industry average of 13%, while its return on investments has trailed the industry, 16% to 20.6%.

Oracle had a busy March. It announced the industry's first unified, end-to-end social management solution for the enterprise. Called Oracle Social Relationship Management (SRM), the new product is part of the Oracle Social Relationship Management Suite. A few days later, the company announced its acquisition of Nimbula, a provider of private cloud infrastructure management software, which is expected to shore up a major weakness in its product portfolio. And the company is expected to release its new T5 microprocessor and M5 system this month. Oracle says its T5 is the fastest microprocessor in the world and explains that its new M5 system can employ up to 32 microprocessors, meaning it can run an Oracle database 10 times faster than the M9000, which the M5 replaces.

These developments came a month after the company announced a deal to buy Acme Packet for $2.1 billion. Acme is a rival to Cisco and Juniper in the delivery of network solutions. In December, Oracle announced a $810 million deal to acquire cloud specialist Eloqua. Since the middle of last decade, Oracle has spent more than $50 billion on more than 80 deals, fueling an expansion in sales and earnings. Company CEO Larry Ellison said the company will continue to seek acquisitions as it wants to increase sales to the banking, retail and telecommunications sectors.

In addition to the recent earnings announcement, other signs of a slightly weakening Oracle include a rate of growth that has slowed since 2009 compared to the several years before 2009. Second, Oracle is facing the prospects of losing its software and hardware business to companies who are switching to Internet-based cloud systems. Furthermore, the company is facing competition in key segments from Salesforce. While the latter is much smaller, it is also growing its revenue faster than Oracle.

None of that is enough to stem analysts' enthusiasm for the company. Of the 44 analysts reporting on the company, 10 have a strong buy and 22 have a buy. None have sell ratings.

Analysts currently have a mean target price of $37.73 and a median target price of $38.00 for Oracle. Analysts are estimating earnings per share of $0.66 with revenue of $9.39 billion for the current quarter ending in February 2013. For the full year, analysts are projecting an EPS of $2.71 with revenue of $38.24 billion, which is 2.70% higher than 2012.

As long as Oracle doesn't miss those targets, the company's stock should appreciate.

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

Business relationship disclosure: This article was written by an analyst at Catalyst Investments.