Sell Oracle After Disappointing Results

| About: Oracle Corporation (ORCL)
This article is now exclusive for PRO subscribers.


Oracle shares dropped 5% after-hours on Thursday as investors digested weak quarterly results.

EPS and revenue missed as weak new license revenue dragged on results, which is indicative of increasing competition in the space.

At the same time, expenses continue to increase, which led to a significant drop in margins.

With slow growth and bloated expenses, investors should wait for shares to reach $37 before buying.

On Thursday afternoon, Oracle (NYSE:ORCL) shareholders were greeted with fairly weak quarterly results. This surprising miss sent shares more than 5% lower in the after-hours session and halted a pretty good run in shares, which had been trading at a fresh 52-week high. Oracle's business has been challenged by smaller cloud company like (NYSE:CRM), and pricing has been under pressure as a consequence. Given these results, I continue to think investors should rotate out of Oracle and into other legacy tech firms like Cisco (NASDAQ:CSCO), which is seeing a bottom in its business.

In its fiscal fourth quarter, Oracle earned $0.92 on revenue of $11.32 billion while analysts were expecting $0.95 on $11.5 billion in revenue (all financial and operating data available here). Year over year, EPS was up $0.05 thanks to aggressive share repurchases while revenue jumped 3.4%. This quarter is traditionally Oracle's strongest, so this miss was a bit jarring, especially considering improving operating performance in previous quarters. Clearly, Oracle's momentum has hit a bit of a snag. In the quarter, new license and cloud revenue was up 2%, which was towards the low end of management's 0-10% guidance range.

While license updates were up 7%, new licenses were flat year over year. Basically, Oracle did a good job of updating existing customers, but it struggled to bring in new business with new license revenue exactly flat at $3.769 billion. With increasing competition as companies like IBM (NYSE:IBM) refocusing on the cloud, it is increasingly difficult to get new business, which weighed on Oracle's results. Additionally at first glance, a 25% jump in cloud as a service seems strong, but this market is growing far faster with companies like Microsoft (NASDAQ:MSFT) reporting growth well in excess of 50%. While this growth seems strong, it likely means Oracle actually lost market share in the quarter.

Oracle also has a tendency to spend aggressively, which weighs on profitability when revenue growth is lackluster. That is exactly what happened this quarter. Even though revenue only jumped 3%, operating expenses increased by 8%. This led to a 2% drop in operating income. In particular, a 6% jump in sales and marketing spending was a bit more than I hoped for. These quarters where expenses outpace revenue growth are frustrating for investors and pinch margins. Net income margins fell to 32% from 35% last year, which led to a 4% drop in net income. In an increasingly competitive market, Oracle needs to do a better job controlling expenses to protect margins.

Overall, license revenue was disappointing, particularly new licenses, and hardware remains relatively stagnant. Increases in expenses also helped to pinch profits during the quarter. Now, management did offer in-line guidance of $0.64-$0.66 on sales growth of 4-6%, though last year is not a particularly challenging comp. After it delivered results towards the bottom of guidance in the past quarter, investors may be discounting this guidance a bit.

Still in fiscal 2015, Oracle is on pace to earn about $3.10 a share, and it has an absolutely pristine balance sheet. Currently, Oracle has $39 billion in cash and marketable securities. Now, much of this cash balance is overseas, so the company has $24 billion in notes payable. With a net cash balance of $15 billion and strong free cash flow, Oracle can continue to repurchase stock. In the fiscal year, Oracle repurchased $9.8 billion in stock, including $3 billion in each of the past two quarters. I would look for Oracle to repurchase another $8-12 billion in stock in the current fiscal year.

On an ex-cash basis, Oracle is trading at about 13x earnings. For a company with slowing revenue growth and increasing competition, that is not a particularly cheap multiple compared to other tech firms like Cisco, Microsoft, and IBM. Given excessive spending and weak new licenses, I would wait for shares to trade 12x earnings or about $37 before initiating a position in Oracle. This quarter was fairly disappointing and showed a deceleration in new licenses. At the same time, increased spending actually led to a drop in net income year over year. Investors should take profits in Oracle and rotate into other tech firms. Until we near $37, there is more downside risk than upside risk for shares.

Disclosure: The author is long CSCO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.