Stock of the week - Oracle (13.12.2023)

• Oracle reported fiscal-Q2 2024 earnings on Monday
• Stock plunged over-12% during post-earnings session
• Cloud growth continues to slow
• Biggest single-day drop since previous earnings release
• A look at the valuation

Oracle (ORCL.US) plunged over 12% on Tuesday, following release of disappointing fiscal-Q2 2024 earnings report (calendar September-November 2023). Another quarter of slowing growth in the company's cloud business has driven the post-earnings plunge, leading to a retest of a key $100 support zone. Let's take a quick look at recent earnings release as well as company's valuation.

Oracle plunges over 12% after fiscal-Q2 results

Oracle plunged on Tuesday in response to the fiscal-Q2 earnings report released on Monday after the close of the Wall Street session. Company missed revenue expectations and showed slower cloud growth for the second consecutive quarter. A disappointing growth in Infrastructure Cloud revenue is a source of concern as shortage of AI chips mean that it is unlikely to re-accelerate in the near term. On the other hand, deceleration in infrastructure cloud revenue, which is the biggest source of revenue for the company, comes after a year of strong acceleration.

On a positive note, it should be said that the company managed to improve its profitability, with margins rising and earnings beating expectations. This points to an improvement in efficiency in a challenging macro environment, what is a development that is always welcome.

Fiscal-Q2 2024 earnings

• Adjusted revenue: $12.94 billion vs $13.1 billion expected (+5.1% YoY)
• Cloud & License revenue: $10.82 billion (+7.9% YoY)
  • Infrastructure Cloud Services & License: $5.16 billion (+14.2% YoY)
  • Applications Cloud Services & License: $4.47 billion (+9.5% YoY)
  • Cloud License and On-Premise License: $1.18 billion (-18.1% YoY)
• Hardware revenue: $756 million vs $742 million expected (-11% YoY)
• Service revenue: $1.37 billion vs $1.41 billion expected (-1.7% YoY)
• Adjusted EPS: $1.34 vs $1.33 expected ($1.21 a year ago)
• Adjusted operating income: $5.54 billion vs $5.56 billion expected (+8.8% YoY)
• Adjusted operating margin: 43.0% vs 42.6% expected (41.0% a year ago)

Oracle's earnings history and price reactions. Source: Bloomberg Finance LP, XTB Research

Oracle plunges most since previous earnings release

A massive plunge of Oracle's stock during the post-earnings session was the biggest one-day drop for the company in 3 months. To be more precise, it was the biggest one-day drop since release of the previous earnings report (fiscal-Q1 2024), which also turned out to be a disappointment by showing a slowdown in cloud business. 

While disappointing fiscal-Q1 earnings could be a one-off event, a similarly disappointing fiscal-Q2 release shows that it may actually be a beginning of a new trend. Nevertheless, it should be said that abnormally high growth rates cannot last forever and a slowdown had to come sooner or later, given that Oracle's cloud business grows and matures.

Release of fiscal-Q2 2024 earnings triggered the biggest single-day drop at Oracle shares since September 12, when fiscal-Q1 2024 earnings were released. Source: Bloomberg Finance LP, XTB Research

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 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 around 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 7% terminal weighted cost of capital (WACC). Such a set of assumptions provides us with an intrinsic value of Oracle's shares of $148.22 - or almost 44% above yesterday's cash close. Terminal value forecast accounts for 72% of DCF valuation.

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

Next, let's take a look at how Oracle's valuation compares with peers. We have constructed a peer group consisting of 5 companies, which are considered to be Oracle's competitors. Those include ServiceNow, Palo Alto Networks, CrowdStrike Holdings, Fortinet 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.

As one can see in the table below, there is a significant volatility in peer multiples. A key point to note is that most of those companies have very low or even negative earnings per share, leading to P/E multiple being very high or incalculable. The same can be said about EV//EBITDA multiples that are inflated due to low profitability of those companies. As a result, mean, median and cap-weighted multiples for the group are very high and provide us with very high valuations for Oracle stock. Trimmed averages for valuations (averages excluding the lowest and the highest reading) are all suggesting a $300-350 valuation for Oracle's shares, or over 200% above yesterday's closing prices!

Source: Bloomberg Finance LP, XTB Research

Gordon Growth Model

Let's move to the third valuation method - Gordon Growth Model. This method relies on dividends and given that Oracle has a long track record of dividend payouts, it can be used to value company's stock. We have assumed an 8% dividend growth rate as well as 9% required rate of return. Such a set of assumptions provides us with a valuation of $146.88 per Oracle's share - or over 40% above yesterday's cash close.

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 (ORCL.US) chart at D1 interval, we can see that the stock painted a double top in the $127.00 area June-September 2023 period, and plunged to the textbook range of the breakout below the neckline of the double top pattern later on. A recovery move was launched off the $100 area. However, all the gains made during November were erased during this week's post-earnings plunge, and share price has once again tested the $100 area. Declines seem to have been halted in this area, at least for now, and a lot will depend on the near-term share price moves. 

Should stock start to recover and break back above recent local highs at $117.50, it could hint at a period of growth ahead given that it would be a new higher high as well as a break above the neckline of double bottom pattern. On the other hand, in case bears regain control over the market and push the stock below $100 area, it would mean that a new lower low was painted and the downtrend could be in play. In such a scenario, the next major support to watch can be found in the $90 area.

Source: xStation5