We are downgrading Oracle and cutting our price target after another bad quarter
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Oracle shares are taking a hit in the aftermarket following another disappointing quarterly report. While earnings at the cloud infrastructure company edged out Wall Street estimates, sales once again came up short with three of the company’s four main operating segments underperforming, including its crucial cloud services division. Revenue for the second fiscal quarter of 2024 (ended Nov. 30) increased 5% year over year to $12.94 billion, missing the consensus analyst estimate of $13.05 billion, according to data compiled by LSEG. Adjusted earnings-per-share (EPS) of $1.34 gained 11% from the year-ago period, outpacing the $1.32 predicted by analysts. Bottom Line We do believe management is doing good things with its second-generation Oracle Cloud Infrastructure (OCI). After all, it was the first big company to offer Nvidia ‘s ground-breaking DGX Cloud supercomputing AI service. Microsoft even tapped Oracle for additional capacity. Plus, there has been an increase in Oracle mentions by chief information officers when asked about future IT spending, according to a recent survey by Piper Sandler. It’s a strategy that could pay off over the long term. On the conference call with investors Monday, management explained that the way OCI was designed — unused resources can be reallocated to other clients and customers are charged only for what they use when they use it — has the potential for a much higher gross profit margin. However, the issue is opportunity cost and where the stock goes in the nearer term. We just aren’t seeing the bookings convert to revenue at a swift enough pace. We defended the company after last quarter’s miss. Our view then was that while the numbers weren’t great, we had heard enough positive commentary to stick with the stock, believing Oracle will ultimately become an AI winner. That is likely still the case. Oracle’s OCI stands to benefit greatly from AI demand, but Monday’s report has us scrutinizing the timing more intensely. The demand appears to be there, the realized sales do not. The main issue is a lack of capacity. The management team said Oracle is working as fast as it can to keep up with the demand. “We have to build 100 additional cloud data centers because there are billions of dollars more in contracted demand than we currently can supply,” said Larry Ellison, the company’s co-founder, chairman and chief technology officer. It’s encouraging to hear that demand isn’t an issue. Indeed, Oracle’s remaining performance obligation (RPO), or future payments, now exceeds $65 billion, more than a year’s worth of revenue. But we question if it’s worth sticking around while the capacity is built out. It won’t be done overnight. And with capital expenditures ramping up over the next two quarters — coming in at around $8 billion for the full year, slightly lower than expectations of $8.27 billion — we are led to believe it will take at least another half-year to get the needed level of capacity to super-charge sales. It certainly isn’t happening this quarter. The company’s third-quarter guidance once again missed on the top line and was just in line on earnings. As much as we’d like to, we can’t defend Oracle again. Management assured investors that this quarter would be better and that is simply not the case. It was a companywide sales miss for the second straight quarter, along with weaker-than-expected operating income and cash flow results. Moreover, when CEO Safra Catz appeared on Mad Money shortly after the last quarter, she made assurances that their $28 billion acquisition of Cerner two years ago would begin to pay off very big very soon — perhaps as soon as this quarter with several billion-dollar contracts. Instead, it looks like it is worse off than the previous quarter and management has glossed over the issues again. We can only conclude the company overpaid for Cerner, not realizing that the future was the cloud. And while the company tries hard to justify the acquisition because of generative AI, things just aren’t adding up. Again, perhaps one day it won’t be a drag, but with the official passing of two years of ownership, we can only conclude that it has been unable to get the kind of big contracts we were hoping for. You could probably ride this out and be a long-term winner, but we just don’t think it’s worth the opportunity cost. One may argue that at less than 20 times forward earnings, it’s a budget way to play the secular AI trend. That may be true. However, what is also true is that management has missed on sales results twice in a row now and just guided for a third quarter to come in lighter than expected. In our view, value multiple or not (for an AI cloud play at least), shares just aren’t going anywhere any time soon. A cheaper valuation doesn’t mean much if the stock is a dead money value trap for the next 6-plus months. Therefore, with the market still in overbought territory according to the S & P Short Range Oscillator (4.95% as of Monday night), we are downgrading ORCL shares to a 3 and reducing our price target to $115 from $130. We may not sell shares at the open Tuesday, but we are looking for an opportunity to unload our position. As Jim noted in his Sunday column , there are areas outside of tech primed for strong gains in 2024 and we would rather have cash at the ready when those opportunities arise. Guidance For Oracle’s fiscal third quarter, management expects total revenues to increase between 6% and 8%, which at the 7% midpoint implies total revenue of $13.27 billion, short of the $13.32 billion expected on the Street (or growth of about 7.5% year-over-year). Excluding Cerner, sales are expected to increase between 8% and 10% versus the year-ago period. Within this guide, Oracle expects cloud revenue to grow 26% to 28%, which at the midpoint is about stable from the first quarter, a slight acceleration from the 25% rate this quarter. On the earnings side, Oracle expects adjusted EPS to grow 10% to 14% year over year to between $1.35 and $1.39 per share, which at the $1.37 per share midpoint is right in line with expectations. (Jim Cramer’s Charitable Trust is long ORCL. 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Safra Catz, CEO of Oracle Corporation, rings the opening bell at the New York Stock Exchange, July 12, 2023.
Brendan Mcdermid | Reuters
Oracle shares are taking a hit in the aftermarket following another disappointing quarterly report. While earnings at the cloud infrastructure company edged out Wall Street estimates, sales once again came up short with three of the company’s four main operating segments underperforming, including its crucial cloud services division.
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