- Oracle stock declined by more than 4% after the company missed analysts' estimates and issued a weak guidance.
- The dollar growth in SaaS and PaaS revenue more than offset the dollar decline in licensing revenues.
- Low risk and attractive valuations make Oracle Corporation stock a good buy.
On Thursday, after the market close, the Delaware-based software company, Oracle (NYSE:ORCL), came out with a mixed earnings report. The traditional licensing business remained stagnant, hardware business took a dive but the cloud business showed strong growth. On the targets front, the company missed analysts estimates on both the top and bottom line and revised its guidance downward sending the stock tumbling 4.5% on Friday. But with cloud revenue growing at fast pace, the possibility of margin expansion, strong fundamentals, and an attractive valuation, many analysts remain bullish with average price target indicating an upside of 13.8% from the Friday's close.
The company reported earnings (non-GAAP) of $0.55 on revenue of $8.61 billion against analysts’ estimates of $0.58 in EPS and revenue of $8.7 billion. The current quarter revenue represents a YoY growth of 1.7%. The cloud revenue grew by 59% , while the hardware revenue was down 11% with licensing revenues remaining flat. The earnings were impacted by the increase in interest payments, sales and general administration expenses, strong dollar and higher tax rates.
SaaS And PaaS Segments Continue To Show Strong Performance
SaaS and PaaS revenues continue to show strong growth. The revenue growth rate in SaaS and PaaS has accelerated in all the last seven quarters. The acceleration was seen in the latest quarter billings too, with SaaS and PaaS billing growing by 49% compared to 39% in the year-ago quarter. The deferred revenue from SaaS and PaaS also saw strong growth, growing by 49% to $1.4 billion. But more importantly, the dollar growth in SaaS and PaaS revenue more than offset the dollar decline in licensing revenues. This is the second consecutive year in which Oracle sold more SaaS and PaaS than any other cloud service provider. To quote Oracle's Co-CEO Mark Hurd from the earnings press release :
"We believe this will be the second year in a row that Oracle has sold more SaaS and PaaS than any cloud services provider. In the first quarter alone, we added more than 750 new SaaS customers including 344 new SaaS Fusion ERP customers – that's more ERP customers than Workday has sold in the history of their company."
One thing which has got some analysts excited is Oracle's improving profitability. The gross profit grew by 3.5% on YoY basis, the fastest in last eight quarters. And the profitability will continue to grow with the margin expansion in SaaS and PaaS business. To quote CEO Safra Catz from Q1 earnings call:
"The Q1 gross margin for SaaS and PaaS was 62%, up from 40% last Q1, and we expect to see further improvements in fiscal year 2017, and from there, we’ll be targeting 80% over time."
Apart from the miss on earnings and revenues, the other thing which bothered many investors was the weak guidance for the second quarter. Oracle expects to earn between 59 cents and 62 cents a share on revenue of $9 billion to $9.27 billion. Analysts were predicting earnings per share of 65 cents on revenue of $9.26 billion. But in spite of the miss and the weak guidance, many analysts reiterated their buy ratings. Heather Bellini of Goldman Sachs reiterated a Buy rating with a target price of $47. To quote him:
“The transition to the cloud means that traditional license revenue will continue to be pressured going forward. That having been said, we believe the decline in this segment has been less than what many bears have feared. Furthermore, we believe that the company’s maintenance revenue will be more resilient albeit at a low single digit growth rate, for longer than some suggest.”
Another analyst who reiterated his buy rating was Raimo Lenschow of Barclays. He reiterated his buy rating with a price target of $48 stating that:
“The stock might be under pressure in the near term due to the maintenance and margin miss, but we think the cloud transition story is coming together nicely,”
He expects the growth in cloud revenues to more than offset the decline in license revenues and improving cloud margins to grow the company's profitability again.
Strong Cash Flows And Attractive Valuations
Oracle has been a strong cash generating company, generating billions of dollars every quarter. In 2016 oracle had generated $13.56 billion in cash from operations and more than $10 billion in free cash flows. In the latest quarter, the operating cash flow came in at $5.8 billion while free cash flow stood at $5.5 billion.
The strong cash flows will help oracle continue its share buy backs and dividend program without any hiccups. In the latest quarter the company bought back $2 billion worth of stock and spent $600 million on dividends. The dividend yield currently stands at 1.49%, which while not that attractive has a lot of room to grow. The current payout ratio stands at 28%. Oracle had more than $14 billion in cash net of debt in the latest quarter.
Another aspect which makes the stock attractive is its valuation. Oracle stock is currently trading at a trailing PE of 18.8 and a forward PE of 12.97. Microsoft (NASDAQ:MSFT) is currently trading at a PE(ttm) of 27.26 and forward PE of 17.78 while salesforce (NYSE:CRM) is currently trading at a PE (ttm) of 226 and forward PE of 57.26. Oracle's PEG ratio is also much lower than the other two.
Recent Stock Performance
Oracle’s stock performance has not been great in last few years. Oracle stock is up 6.5% YTD while Nasdaq Composite (INDX:COMPX) is up by 4.7%. But in last five years, Nasdaq Composite has doubled while Oracle stock has returned around 37%. The slow down in revenue growth and uncertainty surrounding the stock due to the ongoing transition has been dragging the stock for a while now.
The latest quarter earnings was a mixed bag for Oracle Corporation with the miss on both top and bottom line, but cloud revenues continuing to show strong growth. The company has strong growth potential and limited downside. Oracle is currently trading at an attractive forward PE of 12.97, much below its 5 year average of 16.75. The average one-year analysts' price target of $44.5 indicates an upside potential of 13.8%, and add to that the dividend yield of 1.49%, the total return an investor could be looking at in one year is around 15.5%. Investors must use this dip as an opportunity to buy into Oracle stock.