QQQ - Is Oracle Stock A Smart Choice Amid AI Hype

2023-10-25 13:01:21 ET

Summary

• Oracle Corporation is one of the largest multinational technology companies in the world.
• Thanks in part to the high demand for the company's innovative products, its operating income margin is significantly higher than its competitors in the technology sector.
• Simultaneously, the company's cloud services revenues were $4,635 million for the first quarter of fiscal 2024, an increase of 29.5% year-over-year.
• On the other hand, investors should note that Oracle's total debt was about $88.94 billion at the end of the first quarter of fiscal 2024, an increase of $13.08 billion from 2021.
• We initiate our coverage of Oracle with an "outperform" rating for the next 12 months.

Headquartered in Austin, Texas, Oracle Corporation (ORCL) is one of the largest multinational technology companies in the world, focused on developing and commercializing data storage systems, database management systems, cloud services, and various virtualization software.

Investment thesis

We highlight three crucial investment theses that are attracting retail and institutional investors. The first is the company's high operating profit margin, amounting to 27.63% for the first quarter of fiscal year 2024, which is also significantly higher than its competitors in the technology sector.

In addition, Oracle's cloud services and license support division, whose sales accounted for 75.9% of its total revenue, continues to grow at a significant pace quarter over quarter. Simultaneously, the company's cloud services revenues were $4,635 million for the first quarter of fiscal 2024, an increase of 29.5% year-over-year, driven by the competitive advantages of its products, increased license volumes sold, and the robust expansion of the global cloud computing market.

In addition, Oracle is one of the beneficiaries of the ongoing euphoria in financial markets caused by a sharp increase in investment interest in companies developing generative AI-based products. We believe that demand for Oracle's second-generation cloud infrastructure will remain extremely high as it is one of the most powerful in the industry, thanks in particular to a technology called Remote Direct Memory Access (RDMA). In addition, at the quarterly call for the first quarter of fiscal year 2024 , Larry Ellison confirmed the lower cost of using this platform relative to competitors, which is one of the key factors for companies and startups looking for reliable partners who can provide immense computing power, including for data management.

So we think we are going to be very, very competitive across the board whether it's training or an inferencing. So we don't -- so we are pretty confident that we've got a cost-performance advantages.

Again, if you run twice as fast in the cloud, you cost half as much because you pay by the hour. So the performance advantage is really an enormous cost advantage for us.

Oracle's Q1 FY24 financial results and outlook for the H2 FY24

Before diving directly into our analysis of fiscal first quarter 2024 financial results and our expectations for fiscal 2024, we want to bring your attention to Oracle's institutional investors.

Although Oracle's gross margin has decreased in recent years, major Wall Street giants such as Vanguard Group, JPMorgan Chase, State Street, FMR, and Blackrock have continued to be its largest shareholders, collectively holding a 14.27% stake in the company.

At first glance, results for the first quarter of fiscal 2024 were encouraging as Oracle's EPS beat analysts' estimates. Even though its revenue continues to grow year over year, it fell slightly short of analysts' expectations. One of the main reasons for this is the lower sales growth rate of the company's products and services in the EMEA region relative to the Americas region.

Oracle is expected to release its financial report for the second quarter of fiscal year 2024 on December 8. According to Seeking Alpha , Oracle's revenue is expected to be $12.97-$13.15 billion, up 8.7% year-over-year and 4.7% higher than analysts' expectations for the previous quarter.

At the same time, under our model, the company's total revenue will be slightly above this range, amounting to $13.2 billion. We expect its quarterly and year-on-year revenue growth will be driven by raised demand for hardware products, cloud infrastructure services, and an increase in the number of customers.

Simultaneously, we forecast that Oracle's operating income margin will reach 28.4% by fiscal year 2024. Simultaneously, by the fiscal year 2025, this financial metric will increase to 29.1% due to an upsurge in demand for hardware products and cloud services of the company, a decrease in the cost of raw materials necessary for the production of Oracle equipment, optimization of labor costs, and the central banks' lowering of interest rates.

According to Seeking Alpha , Oracle's second-quarter EPS is expected to be $1.31-$1.37, up 14.8% from the consensus estimate for the first quarter of fiscal 2024. At the same time, according to our model, Oracle's EPS will be in this range and reach $1.34.

However, the company's Non-GAAP P/E [TTM] is 20.46x, 13.44% higher than the sector average and 24.25% higher than the average over the past five years. Moreover, Oracle's Non-GAAP P/E [FWD] is 19.5x.

Unlike many companies in the technology sector, Oracle's cash flow to repurchase its shares has remained relatively low in recent years, primarily due to its extremely high debt and its acquisition of Cerner at the end of 2021 . For the three months ended August 31, 2023, Oracle repurchased about $1.21 billion of its shares. At the same time, at the end of the first quarter of fiscal year 2024, the remaining authorization to buy back company shares amounted to $8.01 billion . Despite this significant amount, we believe that Oracle management will not pursue an aggressive share repurchase policy until its total debt/EBITDA ratio falls below 3.5x.

At the end of the first quarter of fiscal 2024, Oracle's total debt was about $88.94 billion, an increase of $13.08 billion over 2022. Moreover, despite the company's EBITDA growing year over year, its total debt/EBITDA ratio increased from 4.1x to 4.51x.

Conclusion

The company's innovative products play a key role in ensuring data security and improving the efficiency of business processes for its clients, including government agencies, large corporations, banks, universities, and more.

The key risks to Oracle's financial position are a decline in its gross margin year-on-year, rising geopolitical tensions in the world, and a strengthening of the US dollar relative to other foreign currencies. These factors have weighed on its share price, which has risen 8.13% over the past six months, underperforming competitors in the technology sector such as Palo Alto Networks (PANW) and ServiceNow (NOW).

Although the company's total debt/EBITDA exceeds 4.5x, we do not expect Oracle to have significant difficulty paying off the senior notes with a maturity date between 2025 and 2053, thanks to its growing cash flow and increased demand for cloud services.

We initiate our coverage of Oracle with an "outperform" rating for the next 12 months.

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