Information technology and cloud computing have traditionally been sectors with companies trading at phenomenal valuations owing to their relatively strong level of resilience as compared to broader markets. However, there is a common trend of contraction of valuation multiples among older IT companies which are relatively slow in innovating. These older players are often playing catch-up to the hot new trends.
Oracle Corp. (ORCL, Financial) is a classic example of one such company that is trading at a much lower valuation as compared to its peers due to its age and slowdown in growth. However, the company has a decent market position in cloud-based services, device management products and enterprise software platforms. I believe that the recent transition to cloud-based offerings could generate a strong upside for the company which might not be factored into the current price.
Company overview
Oracle is an older IT company that was founded way back in 1977. It is known to be the creator of Java, the world's number one programming language and developmental platform. The Java management service and the Java software subscription provide recurring revenue for Oracle.
The company is now moving into the cloud market for growth, focusing on the Enterprise Resource Planning (ERP) category, where it has a strong market position in terms of on-premise offerings along with SAP (SAP, Financial). Oracle's cloud-based services cater to more than 30,000 companies worldwide. Their cloud business shows promising growth signs, and they are looking to become the largest provider of cloud ERP systems.
Recent financial performance
Oracle reported a decent financial result for its recent fiscal quarter ended Aug. 31. Its top-line of $9.73 billion showed 3.85% growth as compared to the $9.37 billion in revenue reported in the corresponding quarter of the previous year. However, the company underperformed the analyst consensus estimate of $9.76 billion.
Their cloud services sales reached $7.4 billion, an increase of 8% year-on-year. In full fiscal 2021, the company's cloud services reached $28.7 billion, representing a 5% increase compared to the same quarter of fiscal 2020.
Oracle’s revenues translated into a gross margin of 78.38% and an operating margin of 35.67%, which were lower than in the same quarter of last year.
Oracle reported net income of $2.46 billion, and its adjusted earnings per share (EPS) of $1.03 outperformed the analyst consensus estimate of 97 cents.
In terms of cash flows, the company reported $5.39 billion in the form of operating cash flows and spent $781 million in investing activities during the previous quarter. The company produced lower cash flows as compared to the same period of the previous year.
Excellent growth opportunities
Oracle has a major growth engine in the form of its Fusion offering. Fusion acts as middleware between corporations and the cloud and helps companies create and run agile, intelligent business applications while maximizing their efficiency through the optimum utilization of their hardware and software architectures. The Fusion segment grew 11% in the recent quarter and is an important driver for Oracle's future.
Another important driver worth mentioning is the company’s Platform-as-a-Service (PaaS) offering that enables developers to rapidly build and deploy cloud and mobile applications. It is looking to expand its portfolio of Oracle Cloud SaaS applications and onboard more and more customers on the Oracle Cloud Infrastructure (OCI), its platform of public cloud services that enables customers to build and run applications in a secure, high-performance environment.
Oracle lags behind the likes of Amazon (AMZN, Financial) Web Services and Microsoft (MSFT, Financial) Azure in terms of the public cloud offering, but its focus is more on the hybrid cloud with a mix of public and on-premise offerings, which could be rapidly adopted by enterprises. This could generate a strong upside for the stock.
ERP migration upside
The Covid-19 pandemic has accelerated companies' transitions into digital operations, and as a company that helps to facilitate digital transformations, Oracle is making the most out of the situation.
One reason why Oracle is not the double-digit cloud growth story that many smaller tech companies are is because its revenue base is significantly larger. Even if the absolute growth is strong, it translates into low-single digit percentage growth.
Its ERP and application subscriptions business is going very strong with products like Fusion ERP (catering to large organizations), NetSuite ERP (catering to smaller businesses) and Fusion HCM. As a matter of fact, Oracle is ahead of rival SAP in its transition process to cloud-based ERP, autonomous databases, ERP data visualization tools and billing. The cloud-based model makes user implementation fast, easy and profitable, while the emphasis on automation allows users to save money on back-end work, which is where the deal can pay for itself. Given its rapid transition progress, it wouldn’t be surprising to me if the company ate into SAP’s market share.
Final thoughts
As we can see in the above chart, Oracle has seen its fair share of appreciation as a result of the digitization trends resulting from the Covid-19 pandemic. One fact that is particularly surprising is that for a company having a 34.19% net margin, Oracle is trading at a price-earnings ratio of hardly 19, which is among the lowest among its software peers. The fact that its recent transition is taking place in a highly competitive environment does complicate the situation and induce fear among the market participants, which is another reason why the valuation is low.
While its top-line growth may be relatively slow, the company’s fundamentals are too solid and its growth prospects too strong for it to deserve a forward price-earnings ratio of 19.01. This is why I feel that multiples expansion is long overdue on the stock. Regular dividends and buybacks should also help appease the yield investors the meantime. Overall, I believe that Oracle is an undervalued technology blue-chip that deserves more attention from tech investors.
