Will Shift To Cloud Spur Rapid Growth For Oracle Stock?

  • Oracle is pushing hard into a cloud platform.
  • Oracle's focus on growing its cloud business rapidly makes sense.
  • The economics of a cloud subscription versus a license plus maintenance deal are more attractive over the long term.

Oracle (NYSE:ORCL) is pushing hard into a cloud platform. From January 2012 to February 2014, Oracle committed nearly $6 billion in capital to acquire cloud software companies RightNow, Taleo, Eloqua and Responsys.

However, will this move return the company to high growth? At Oracle CloudWorld on January 20, in New York, the company was promoting its cloud products at the expense of on-premise products. According to Oracle, while the on-premise version of an Oracle database requires 84 steps to deploy and would take weeks or months, the cloud version could be deployed in 5 steps and would take 30 minutes.

On one hand, Oracle's focus on growing its cloud business rapidly makes sense, because the economics of a cloud subscription versus a license plus maintenance deal are more attractive over the long term. However, on the other hand, total cloud revenues accounted for only 7% of total revenues in its latest quarter. Nevertheless, cloud revenues are growing at an average annual compounded rate of 34%.

Moreover, according to the company, the bookings growth that it has been experiencing will translate into a significant acceleration in software-as-a-service (SaaS) and platform-as-a-service (PaaS) revenue growth in Q3, where it could hit 50% revenue growth and in Q4 where it should be even higher. Oracle is the first company to make  a complete cloud Enterprise resource planning (ERP) suite for mid-size and large enterprises.

By pioneering this market, it has become the ERP market leader with over 1,500 cloud ERP customers. Cloud ERP is now its fastest growing SaaS application suite. What's more, Oracle believes that the fiscal year 2016 is a trough year for profitability, as it moves to the cloud. All in all, the transition to the cloud is happening faster than expected which, in the long run, will benefit the company.

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Oracle Stock Price

Since the beginning of the year, Oracle stock is up 0.3% while the S&P 500 Index has decreased 5.7%, and the Nasdaq Composite Index has lost 9.5%. However, since the beginning of 2012, the Oracle stock has gained only 42.8%. In this period, the S&P 500 Index has increased 53.2%, and the Nasdaq Composite Index has risen 74%. According to TipRanks, the average target price of top analysts is at $42.67, up 16.5% from its February 17 close price, which appears pretty reasonable.

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Chart: TradeStation Group, Inc.

Valuation

Oracle's valuation metrics are pretty good. The trailing P/E is at 17.61, and the forward P/E is low at 12.94. The quick ratio is very high at 4.20, and the price to cash ratio is very low at 2.94. Furthermore, the Enterprise Value/EBITDA ratio is also low at 9.18.

In addition, Oracle's Margins and Return on Capital parameters have been much better than its industry median, its sector median and the S&P 500 median as shown in the tables below.

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Source: Portfolio123

Oracle has strong balance sheet, and it is generating high free cash flow. The company had $52.34 billion in cash and equivalents at the end of the last quarter, and $41.94 billion in total debt. Oracle bought back 86 million shares for $3.25 billion in the second quarter of fiscal 2016, and 75 million shares for $2.9 billion in the previous quarter, above its historical pace of about $2 billion worth per quarter.

Oracle started to pay a dividend In April 2009. The forward annual dividend yield is at 1.64%, and the payout ratio is only 26.9%. The annual rate of dividend growth over the past three years was very high at 28.6%, and over the past five years was also high at 20.6%.

Summary

Oracle is pushing hard into a cloud platform. The company's focus on growing its cloud business rapidly makes sense, because the economics of a cloud subscription versus a license plus maintenance deal are more attractive over the long term. All in all, Oracle's transition to the cloud is happening faster than expected which, in the long run, will benefit the company.

Oracle's valuation is good; the forward P/E is low at 12.94, and the Enterprise Value/EBITDA ratio is also low at 9.18. Moreover, the company has strong balance sheet, it generates strong free cash flow, and returns substantial capital to its shareholders by stock buybacks and increasing dividend payments. The average target price of top analysts is at $42.67, up 16.5% from its February 17 close price, which appears pretty reasonable. All these factors bring me to the conclusion that Oracle stock  is a smart long-term investment.

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Comments on this article and ORCL stock

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ilya_geller
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No. IBM already began to provide its cloud services for unstructured data.
Oracle ATG lost its exclusivity.
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