Oracle Earnings Preview: Safe, Older Tech Stock, But Not Without Cloud-Related Issues

Summary

• Ultimately, as a software giant, Oracle needs faster revenue growth.
• The non-legacy business tied to Saas, Paas and Iass, has struggled to get traction.
• The legacy "stand-alone" dbase business has gradually eroded the last 5 - 7 years.
• Oracle's relative performance versus the SP 500 has been pretty bad.
• Oracle is fairly-valued on most metrics given low-single-digit rev growth.

Oracle (NYSE:ORCL) the database software giant that remains under pressure since the emergence of the cloud is both an opportunity to Oracle and a competitive threat, is scheduled to report their historically-strong fiscal Q4 earnings on Tuesday, June 16th, 2020, after the closing bell.

Street consensus per IBES by Refinitiv is expecting $1.19 in earnings per share (vs $1.16 in last year's fiscal Q4) and $10.87 billion in revenue for expected year-over-year growth of 3% in earnings on a 2% y/y decline in revenue.

The stronger dollar the last 18 months has not helped Oracle.

Expectations for fiscal 2021 as they stand today also by IBES by Refinitiv are for full-year EPS of $4.13 on $39.7 billion in revenue for expected year-over-year growth of 7% in earnings on 1% revenue growth.

Quarterly guidance for Oracle is always important but it isn't given the same level of importance as the how the annual numbers change. The May quarter every year is typically Oracle's strongest and this expected Q4 '20 - using consensus estimates - is 27% of full-year revenue and 30% of expected full-year EPS for the software giant.

Readers should watch how fiscal 2021 estimates change after the release and conference call.

Oracle's EPS and revenue estimate revisions:

Showing readers the expected EPS and revenue growth rates along with the corresponding PE's is a short-cut to save time:

EPS:

(Source: internal valuation spreadsheet)

PE ratio:

(Source: internal valuation spreadsheet)

Revenue:

(Source: internal valuation spreadsheet)

Readers can see for both Oracle EPS and revenue, the expected growth rates for 2020 have declined while the expected revenue growth has stayed fixed in the low-single digits.

The erosion began before the onset of Covid-19 and the shelter-in-place too.

Fiscal '21 EPS growth is looking stronger, while revenue is not. 1% expected revenue growth for 2021 is impressing no one.

Oracle's cash position:

(Source: internal valuation spreadsheet)

Oracle's cash position particularly as a percentage of market cap is worth highlighting to readers: it shows that cash and securities have fallen from 36% of Oracle's market cap as of the passage of Tax Reform in late 2017, to just 18% as of February '2020.

Just like Cisco, what Oracle did was repatriate a lot of the overseas cash and used it to repurchase stock.

Oracle's share repurchases since tax reform passed:

(Source: internal valuation spreadsheet)

Readers can see the bulge between August, 2018 and February '19 where Oracle repurchased almost $30 billion of their own shares in the open market.

So what's the issue? While not a major problem yet, Oracle's history of doing large stock-for-stock acquisitions and using stock options to heavily compensate the acquired company's management, who then sell their shares after the lock-up period requiring Oracle to use a big chunk of their repurchase plan to sop up insider selling is not the preferred way to use that excess cash.

Warren Buffett cited in this the late 1990's as the "sell-high, buy-low" school of investing.

It is shareholder destruction in the quietest of fashions.

Oracle and Cisco are similar in this regard in that both have historically been "serial diluters" of their shareholders.

The positive for Oracle is that they haven't done a large acquisition since NetSuite's $9.6 billion merger in 2016, which is a plus for the dilution issue.

The negative for Oracle is that they need these acquisitions to stay relevant in the industry, as the cloud caught Oracle unprepared in terms of their legacy business.

Oracle's stock performance:

Thanks to YCharts, readers can clearly see the under-performance of Oracle's stock (orange line) since the peak of large-cap Tech in early, 2000.

Oracle give up roughly 180 bp's in annual total return vs the SP 500 in the last 20 years.

(Source: Ycharts)

This graph shows the last 10 years of relative performance for Oracle and the average, annual return shortfall relative to the SP 500 is even worse at 350 bp's negative differential.

However, for defensive investors who might like the 1.75% dividend yield, here is a monthly chart of Oracle that shows steady, consistent appreciation:

(Source: Worden Gold charting system)

Oracle's $45 peak in early 2000, wasn't actually convincingly taken out until 2017, or 17 years after the prior peak.

That's a long time.

For readers who want to manage the risk of owning Oracle, a trade back below $45 for any length of time wouldn't be positive. That would be my loss limit or stop limit for Oracle. Below $45 is not good.

Oracle's dividend policy: Tells you more than you think

Unlike most companies, Oracle doesn't raise their dividend annually and goes long stretches just maintaining the dividend, although over the last 5 years, Oracle's dividend has increased nicely.

This "policy" (and here is Oracle's dividend history) is part-and-parcel to Oracle's acquisition strategy and using the stock as currency, which requires the software giant to retain cash and put the primary emphasis on stock repurchases to keep dilution at bay.

If the recent pattern holds, the current $0.24 quarterly dividend will be maintained for another year, and then investors will see another increase.

Valuation metrics:

• Expected 3-year EPS gro rate: 6%
• Expected 3-year rev gro rate: 1%
• 3-year PE: 13x
• Price-to-sales: 3.7x
• Free-cash-flow yield: 8%

(Source: internal valuation spreadsheet)

One last point - Quality of earnings:

(Source: internal valuation spreadsheet)

Geeky stuff, but one aspect to Oracle's valuation and cash-flow metrics that always bothered me is that as a percentage of net income, cash-flow and free-cash-flow (FCF) never had the kind of coverage that say a Microsoft has, which has cash-flow and FCF coverage of net income of 400% - 500%.

Free-cash-flow coverage of net income is less than 1x for Oracle.

Summary / conclusion: In terms of business model transition, Oracle is very similar to Cisco, IBM, Intel, Microsoft, or the tech giants from the 1990's, meaning Oracle is in the middle of a 20-year transition of their 'stand-alone user" database model trying to shift to the cloud, which represents both an opportunity and a threat to the software giant, as revenue growth remains paltry for Oracle.

Oracle looked like they were successfully making the transition to Saas (software-as-a-service), Paas (platform-as-a-service) and Iass (Infrastructure-as-a-service) until May '18 when the company unceremoniously stopped disclosing the segment data which is a way of communicating to shareholders that there is little good to see.

For the last several years, organic software licenses were declining mid-single digits for years, and basic software support was 50% of Oracle's total revenue, which only grew low to mid-single-digits as well.

Oracle needed that cloud product to gain traction and drive growth, but according to Morningstar, the combination of "basic software support" and cloud revenue was 71% of Oracle's total revenue and grew just 4% y/y last quarter, and that noSQL and Hadoop were gaining on or eroding Oracle's traditional legacy dbase business.

If the cloud business and Netsuite ever gained traction, Oracle would become like Microsoft in a hurry but that is still nowhere in evidence.

Covid-19 could be another challenge for Oracle. While other tech companies clearly benefitted from the pandemic, it will be interesting to see if Oracle clients fled the legacy business faster than in prior quarters. I have no insight into that whatsoever, so readers should watch for the growth or decline in the new software licenses in the May quarter and see if the trend changes materially.

I've written many articles in Seeking Alpha over the years (here, here and here) but have reduced the frequency of the articles since the story hasn't really changed.

The question as to whether the cloud or is "more opportunity or threat" is still undecided at this point, and the stock has been a chronic underperformer. The stock has defensive characteristics for conservative investors, but the acquisition strategy using the stock, and the emphasis on buybacks, keeps the dividend lower than it should be for a stable and consistent grower.

One client has a $28 cost basis position at $28 per share and another client has another small position in the stock. Relative to total assets the position size is immaterial right now.

The May quarter every year is typically Oracle's strongest, but Covid-19's influence on the quarter remains unknown right now.

Analyst’s Disclosure: I am/we are long ORCL. 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.

ORCL reports Tuesday 6/16 after the close