Stock of the week - Oracle (14.03.2024)

• Oracle jumps almost 12% after fiscal-Q3 earnings
• The biggest single-day jump since December 2021
• Results show big increase in demand
• Company expects to recognize 40% of remaining performance obligation in next 4 quarters
• Oracle's cloud revenue still trails Microsoft and Amazon
• A look at valuation
• Stock reaches new all-time high

Oracle (ORCL.US) stole the show on Wall Street on Tuesday, rallying almost 12% and helping revive the tech rally. Spike on the company's shares was triggered by release of solid fiscal-Q3 2024 earnings (calendar December 2023 - February 2024 period). Release showed a big increase in demand for company's products and services, pushing the stock to all-time highs. Let's take a look at the release and company's valuation!

Earnings report shows strong cloud demand

Earnings report from Oracle for fiscal-Q3 2024 (calendar December 2023 - February 2024) turned out to be a positive surprise. While company reported overall sales that were in-line with expectations, revenue growth was driven by strong demand for cloud products. Company's remaining performance obligation increased from $65.5 billion in fiscal-Q2 to $80.2 billion in fiscal-Q3, and Oracle said that it expects to recognize around 40% of it as revenue during the next four quarters!  A jump in performance obligation is driven by increased demand for Oracle's Cloud Infrastructure. While company's gross profit and net income were slightly lower than expected, they still managed to grow year-over-year, with net income growth exceeding sales growth.

Fiscal-Q3 2024 earnings

• Adjusted revenue: $13.28 billion vs $13.28 billion expected (+7.1% YoY)
• Cloud revenue (IaaS and SaaS): $5.1 billion vs $5.06 billion expected (+24% YoY)
  • Cloud Infrastructure (IaaS): $1.8 billion vs $1.69 billion expected (+50% YoY)
  • Cloud Application (SaaS): $3.3 billion vs $3.3 billion expected (+14% YoY)
• Revenue by offering:
  • Cloud services and license support revenue: $9.96 billion vs $9.85 billion expected (+12% YoY)
    • Applications cloud services and license support: $4.58 billion vs $4.45 billion expected (+10% YoY)
    • Infrastructure cloud services and license support: $5.38 billion vs $5.3 billion expected (+13% YoY)
  • Cloud license and on-premise license revenue: $1.26 billion vs $1.2 billion (-2.5% YoY)
  • Hardware revenue: $754 million vs $769 million expected (-7% YoY)
  • Services revenue: $1.31 billion vs $1.37 billion expected (-5% YoY)
• Adjusted gross profit: $9.41 billion vs $9.65 billion expected (+5.1% YoY)
• Adjusted gross margin: 55.5% vs 72.9% expected (73.5% a year ago)
• Adjusted operating income: $5.79 billion vs $5.71 billion expected (+12% YoY)
• Adjusted operating margin: 44.0% vs 42.9% expected (42.0% a year ago)
• Adjusted net income: $2.4 billion vs $2.71 billion expected (+26.6%)
• Adjusted net margin: 18.1% vs 19.2% expected (15.3% a year ago)
• Adjusted EPS: $1.41 vs $1.38 expected ($1.22 a year ago)
• Free cash flow: $3.8 billion vs $2.21 billion expected  (+130.8% YoY)
• Remaining performance obligation: $80.20 billion vs $59.28 billion expected (+28.7% YoY)
  • Current remaining performance obligation: $34.49 billion vs $32.38 billion expected (+15.3% YoY)

Financial dashboard for Oracle. Source: Bloomberg Finance LP, XTB Research

Oracle jumps the most since December 2021!

Oracle shares surged following release of fiscal-Q3 2024 earnings report. Share price closed almost 12% higher on Tuesday, marking the biggest single-day jump for the stock since December 2021. Moreover, it was also the highest close on the record, with stock fully erasing a downward correction from September-October 2023, that was triggered by disappointing fiscal-Q1 earnings release. 

Source: Bloomberg Finance LP, XTB Research

How Oracle compares with other cloud companies?

Oracle had a very strong quarter and share price rally in response to solid earnings release should not come as a surprise. However, how does the company compare to other cloud companies? This is a tricky question.

Amazon's AWS and Microsoft Azure are the biggest cloud providers right now. Comparing multiples of Amazon and Microsoft with Oracle multiples would be misleading as the Amazon and Microsoft are not pure-cloud companies, and are also engage in other activities, like for example e-commerce in case of Amazon. We can, however, compare cloud revenue of those companies. Data for the past 20 quarters on cloud-related revenue from Amazon, Microsoft, Google and Oracle has been presented on the chart below.

As one can see, there is a huge gap between cloud-related revenue of Amazon and Microsoft compared to Oracle or Google. Moreover, as one can see, this gap has widened significantly over the past 20 quarters. Also, Oracle's cloud revenue growth rates are somewhat disappointing compared to Amazon, Microsoft and Google. 

Nevertheless, it should be noted that the comparison provided on the chart below are not perfect - while reporting periods for Amazon, Microsoft and Google are equal to calendar quarters, this is not the case for Oracle. The most recent data on the chart for Oracle is for the December 2023 - February 2024 period, while for the other three companies it is for October - December 2023 period.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

A look at valuation

Let's take a quick look at Oracle's valuation with 3 often used valuation methods - DCF, multiples and Gordon Growth Model. We want to stress that those valuations are for presentation purposes only and should not be viewed as recommendations or target prices.

Discounted Cash Flow (DCF) method

Let's start with probably the most popular fundamental model for valuing stocks - Discounted Cash Flow method (DCF). This model relies on a number of assumptions. We have decided to take a simplified approach and base those assumptions on averages for the past 5-years. Detailed forecasts for 10 years were made, with terminal value assumptions being set as follows - 3% terminal revenue growth and 6.5% terminal weighted cost of capital (WACC). Such a set of assumptions provides us with an intrinsic value of Oracle's shares of $196.97 - or almost 57% above yesterday's cash close. Terminal value forecast accounts for around 73% of DCF valuation. It should be noted that basing assumptions on 5-year averages does not fully capture potential coming from an increased cloud demand due to AI revolution. Having said that, the valuation provided can be seen as somewhat conservative.

A point to note is that the intrinsic value obtained via the DCF method is highly sensitive to assumptions made. Two sensitivity matrices are provided below - one for different sets of Operating Margin and Revenue Growth assumptions and the other for different sets of Terminal WACC and Terminal Revenue Growth assumptions.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Multiples valuation

Next, let's take a look at how Oracle's valuation compares with peers. We have constructed a peer group consisting of 9 companies generating more than 50% of their revenue from Infrastructure Software industry - Microsoft, ServiceNow, Palo Alto Network, Fortinet, Twilio, Splunk, Akamai Technologies, CrowdStrike Holdings and Zscaler. We have taken a look at 6 different valuation multiples - P/E, P/BV, P/S, P/FCF, EV/Sales and EV/EBITDA.

Taking a look at the table below, we can see that there is a lot of volatility in multiples for Oracle peers, with companies with smaller capitalization often being outliers. Means, and to lesser extent medians, are inflated by this. Having said that, we have decided to calculate capitalization-weighted multiples and base valuations on them. Using cap-weighted multiples provides us with valuations ranging from $47.99 in case of P/BV multiple to $275.65 in case of EV/EBITDA multiple. A trimmed mean (excluding the highest and lowest valuations) provides us with an intrinsic value of $236.53 per share, or almost 90% above yesterday's cash closing price.

Source: Bloomberg Finance LP, XTB Research

Gordon Growth Model

Oracle has been paying out dividends on a regular basis since 2009. As a company with a decent almost 15 year long track record of dividend payouts and dividend increases, Oracle can be valued used a Gordon Growth Model - valuation method based on dividends. We have assumed an 8% dividend growth rate as well as 9% required rate of return, based on averages and trends in the past 5 years. Running a model with such assumptions leads us to an intrinsic value of $146.88 per share, or around 17% above yesterday's closing price.

As it is usually the case with valuation models, the Gordon Growth Model is also highly sensitive to assumptions made. Sensitivity matrix for dividend growth and required rate of return assumptions is provided below. Green tiles show combinations that result in above-market valuation, and red tiles show combinations that result in below-market valuations.

Source: Bloomberg Finance LP, XTB Research

A look at the chart

Taking a look at Oracle chart (ORCL.US) at D1 interval, we can see that the stock launched Tuesday's trading with a massive bullish price gap. A post-earnings surge pushed the stock above $114.00 price zone as well as the $117.50 - the level of double top from November 2023 and February 2024. Stock rallied to the $127.50 area, marked with June-September 2023 double top, and managed to climb at the highest level in history. However, the rally did not extend into Wednesday, with stock pulling back slightly.

Source: xStation5