Investment Thesis
In my last article on Oracle Corp (NYSE:ORCL), published in March 2024, I talked about the company’s third-quarter earnings and analyzed the company’s plans to capitalize on the AI boom. I had a HOLD rating on the stock. Since my article was published, the stock has gained 8.7%, handily outperforming the S&P 500, which gained 5.1% during the same period.
In this article, I dissect the company’s fourth-quarter earnings report and analyze the implications of some major developments that have taken place during the period.
Fourth Quarter Highlights
Oracle missed on both the top- and bottom- lines during the fourth quarter. Q4 revenues came in at $14.29 billion, and while it was up 3.25% y/y it missed analyst estimates by $278.65 million. Non-GAAP EPS came in at $1.63, down 2.4% y/y and missing analyst estimates by $0.02. Cloud infrastructure (IaaS) stood out once again this quarter, with revenues from the segment jumping 42% y/y in constant currency. The Cloud Application segment registered a smaller growth, coming in at $3.3 billion, which translates to a 10% y/y growth in constant currency. Non-GAAP operating margins registered strong growth during the quarter, jumping 47% y/y.
For the full year, the company’s total revenues came in at $53 billion, registering a growth of 6% y/y. Non-GAAP operating margins for the full year came in at 44% and the company generated $5.56 in non-GAAP EPS.
For the first quarter of FY25, revenues are expected to grow in the range between 6 and 8% in constant currency, and non-GAAP EPS is expected to grow in the range between 11 and 15% and come in anywhere between $1.31 and $1.35. Management also expects its cloud infrastructure to grow faster in FY25 than the 50% growth registered in FY24. Capital expenditures during FY25, on account of the company’s projected demand, are expected to be double that of what the company spent in FY24. The company also announced a quarterly cash dividend of $0.40 with a payment date of July 25, 2024.
No Stopping ORCL’s RPO Momentum
If ever there was a sign that investors needed as proof that the AI-driven rally in the markets was real, they don’t need to look further than ORCL’s quarter. Despite the company missing out on both the top and bottom-lines, the stock was up more than 13% following the earnings release. And this is because once again, just like in Q3, the company’s Remaining Performance Obligations (RPOs) have stolen the show.
Q4 RPOs grew 44% y/y to a whopping $98 billion, which also represents an $18 billion increase from Q3. Management expects 39% of this amount to come in the next twelve months, which translates to $38.2 billion. Q3 and Q4 together became the quarters when the company signed the largest sales contracts in its history as the AI demand shows no signs of slowing down.
The company’s Cloud infrastructure segment (IaaS) once again registered a 40%+ growth, jumping 42% y/y. And this is on the back of the 49% y/y growth that the company registered in Q3. This quarter, the company announced that the entity that started the AI revolution, ChatGPT owner OpenAI signed to “run deep learning and AI workloads” on the Oracle Cloud Infrastructure (OCI). In total, including OpenAI, 30 AI contracts were signed this quarter, whose total value exceeds $12 billion. Furthermore, the company also signed a deal with Google whereby Google Cloud will offer OCI database services. The company plans to build 12 OCI data centers inside the Google Cloud as part of the deal, and the company expects the database to be available within the Google Cloud by September 2024.
In addition to these new deals, the company also announced that its partnership with Microsoft made significant progress as 11 of the 23 OCI data centers that the company was planning to build inside Microsoft Azure have gone live.
According to Fortune Business Insights, the global IaaS market is projected to grow from $156.93 billion in 2024 to $738.11 billion by 2032, which translates to a CAGR of 21.4%. In my opinion, ORCL, through OCI, stands to be a major beneficiary of this boom. This is not only because the company plans to invest massively in building data centers but also because it has moved fast to sign deals with the major AI players. As things stand, based on management commentary during the earnings call, the company’s AI partners who have signed up to use their data centers include xAI, OpenAI, and Coherent. Moreover, two of the major cloud players (Microsoft and Google) have also signed multi-cloud agreements with the company.
Management, during the earnings call, did show interest in partnering with Amazon Web Services (AWS), while responding to an analyst question. Given that the world is moving towards multi-cloud adoption, I wouldn’t be surprised if the company does sign a deal with AWS in the coming quarters. Irrespective of whether the deal happens or not, Q4 has shown that ORCL is in a strong position to capitalize on the AI boom via its data centers. No surprises then that the company plans to double its capex spend in FY25.
Magnitude of Capex Spend Not a Major Concern Yet
One of the key takeaways from the Q4 earnings report was the management’s update on the Capex spend. Capital expenditures for FY24 amounted to nearly $6.9 billion. During the earnings call, as mentioned earlier, management said that they are expecting Capex spending to double in FY25, which would imply that the figure for FY25 would be nearly $14 billion, significantly higher than the management’s earlier prediction of $10 billion.
While this is a massive figure, especially at a time when enterprise spending on AI is slowing down, it is an essential expense, especially after the new deals signed, during Q4, with OpenAI and Google. Management, during the earnings call, was very enthusiastic about the company’s ability to build different types of data centers for AI (there were references to Boeing 747s, submarines, and so on to further drive home the message), so it is natural to be wary given how staggering the amount is.
However, all one needs to do is to look at the company’s cash flow statement to see that this is a company that has become a free cash flow generating machine. In FY24, the company generated $11.8 billion in free cash flows, which represents a y/y growth of 39%. And while FCF growth did slow down compared to FY23, when it was 68%, it’s the magnitude rather than the percentage that should mitigate any concerns about the company’s capital expenditure spend. Furthermore, the company’s confidence in continuing to generate FCF was further evident when it declared a dividend on top of the capex announcement.
The magnitude of capex spend is something that investors should keep an eye out for, in my opinion. However, given the company’s ability to generate free cash flows together with the fact that most of the company’s customers are major AI players rather than a typical enterprise customer offsets some of the concerns surrounding the capex figure.
Valuation
|
Forward P/E Approach |
|
|
Price Target |
$138.00 |
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Projected Forward P/E Multiple |
22.2x |
|
Actual FY24 EPS |
$5.56 (vs. my estimate of $5.60) |
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FY25 Earnings Growth |
11.3% (same as last time) |
|
Projected FY25 EPS |
$6.20 (vs. previous estimate of $6.23) |
Sources: Company’s Q4FY24 Earnings Call Transcript, LSEG Workspace (formerly Refinitiv), Seeking Alpha, and Author’s Calculations
ORCL, according to LSEG Workspace (formerly Refinitiv), currently trades at a forward P/E of 22.2x, in line with some of its peers such as Salesforce (22.1x) and Alphabet (21.7x), but cheaper than some others such as Microsoft (33.3x), SAP (34x), and Workday (28.6x). Historically, the company has traded at cheaper levels. For instance, the 2-year historical median forward P/E multiple has been 17.6 and its 5-year historical median forward P/E multiple has been 15.2x.
The last time I wrote about ORCL, I assumed the company’s forward P/E multiple to be 21x, which is what it was trading at the time. My logic behind using this multiple at the time was based on the surge in growth seen in its cloud infrastructure segment along with the potential gains from the AI boom. This quarter has seen more developments, and the partnership with OpenAI and Alphabet implies that the company has now partnered with nearly every major AI player. And this is reflected in the surge seen in the company’s fourth-quarter RPOs. As such, I have used the higher forward P/E multiple of 22.2x for my calculations.
I had assumed Q4 EPS to come in at $1.66 and the company narrowly missed my estimate by $0.03. The actual FY24 non-GAAP EPS missed my estimate by $0.04 ($5.6 estimated vs. $5.56 actual). Nonetheless, the company generated a y/y growth of 8.6%, not far off from the company’s FY26 EPS growth target of more than 10%, and significantly higher than the company’s trailing 5-year EPS growth of 5.3%.
According to Seeking Alpha, the company’s forward PEG ratio now stands at 1.79, slightly lower than my previous estimate of 1.86 but in line with its 5-year average of 1.77. Assuming a forward P/E of 22.2x and a forward PEG ratio of 1.79 would result in an earnings growth of 12.4%, which in my opinion would be an overly optimistic assumption. Management has set itself a target of achieving EPS growth of more than 10% only by 2026. I do believe, however, that the company would achieve this target in FY25 due to the significant progress made in the cloud infrastructure space. I have, therefore, maintained my previous estimate of earnings growth of 11.3% for my calculations. This growth estimate would result in a forward PEG ratio of 1.96, in line with the industry median.
At an earnings growth of 11.3%, the company’s FY25 EPS would come in at $6.20, which is not far from the analyst consensus of $6.28. A forward P/E of 22.2x and an FY25 EPS of $6.2 would generate a price target of $138, which is around the levels that the company is currently trading.
The little to no upside on the stock should not be surprising given that the stock jumped more than 13% following its impressive earnings release. The stock is also up nearly 31% YTD. Although I am bumping my price target from last time ($138 vs $131), I am currently not seeing any upside at these price levels. Therefore, I am maintaining my HOLD rating on the stock.
Risk Factors
ORCL’s main risk factor is similar to the one faced by the likes of CRM, which is the slowdown in enterprise spending as CIOs figure out how best to incorporate AI into their companies. While ORCL signed major deals with the likes of OpenAI and Google, these deals benefited the company’s IaaS segment. The SaaS division, on the other hand, did witness slowing growth, which can be attributed to a slowdown across the company’s suite of Cloud apps. So, while it’s good news that the company is benefiting from the AI boom, the slowdown in the SaaS segment is one for investors to keep an eye out for.
Then there’s the risk that I mentioned last time, which is whether the company would be able to generate the desired ROI from the significant amount that has been allocated for capital expenditures. Management, during the earnings call, has already announced that the Capex spend in FY25 could be double of what it spent in FY24. Whether the company manages to maintain its IaaS growth in the coming quarters is, therefore, a crucial element that investors have to be wary about.
Concluding Thoughts
Despite a top- and bottom-line miss, ORCL shares still managed to have one of their best days, as they jumped more than 13% following the earnings release. This can be attributed to more evidence, which suggests that ORCL could be a major AI beneficiary.
The company announced that it has signed deals with OpenAI and Google for training AI models and for its database services respectively, both of which are major wins for its cloud infrastructure segment. At the same time, the company’s RPOs jumped 44% y/y to $98 billion, of which, approximately $38 billion are expected in the next twelve months. The company also made significant progress in its partnership with MSFT as it brought more of its data centers live on Azure.
The company also generated $11.8 billion in free cash flows for FY24 and also declared a dividend of $0.40. While from a valuation perspective, there is little to no upside at current levels thanks to the recent surge seen in the stock, this is a company that, in my opinion, can be added to your portfolio in the event of a meaningful pullback. While its cloud segment might be showing signs of slowing growth, its cloud infrastructure segment is all set to offset that, thanks to its deals with those companies that are at the forefront of the AI revolution.
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