Oracle: Earnings Beat Shows Why Rally Can Continue

• ORCL has dodged the tech sell-off, declining just 7% year-to-date at Monday’s close
• Fiscal Q2 earnings highlight the strength driving investor optimism
• With strong cloud growth and a reasonable valuation, ORCL can continue to outperform

Oracle (NYSE:ORCL) is a legacy software developer whose core products were built in the pre-cloud age. Competing with newer, nimbler, “cloud-native” rivals is not easy; the industry is littered with examples of those who failed.

Oracle is also trying to build out its own cloud offering — and competing against some of the world’s great tech companies in the process. It’s doing so after giving Amazon.com (NASDAQ:AMZN) a significant head start, with Microsoft (NASDAQ:MSFT) and Alphabet (NASDAQ:GOOGL) (NASDAQ:GOOGL) also giving chase.

And yet, Oracle is getting it done. Both strategies are working well. As a result, ORCL stock has sharply outperformed those rivals so far this year.

The gap may widen further on Tuesday, given that ORCL has gained 2% after-hours Monday after a strong fiscal second-quarter earnings report. With momentum behind the business and a reasonable valuation still underpinning the stock, there’s a strong case that the rally should continue.

Why Earnings Strengthen The Case

The headline numbers for Q2 earnings look strong. Both revenue and adjusted earnings per share nicely topped analyst expectations. The outlook for Q3 looks particularly strong: Oracle expects constant-currency revenue growth of 21% to 23%, while Wall Street, on average projected a 17.4% increase. 

But the strength in the quarter goes beyond the headlines. Oracle is executing well. It’s going toe to toe with other cloud giants. Before the quarter was announced, it won a share of a $9 billion contract with the U.S. Department of Defense. On the Q2 conference call, founder and Chief Technology Officer Larry Ellison said the company had signed “multiple” billion-dollar contracts for its infrastructure cloud business. 

Meanwhile, the same macroeconomic cycle pressuring other software companies seems to be having little, if any, impact on Oracle’s business. The NetSuite ERP (enterprise resource planning) — a large and expensive platform — is seeing steady demand and growth near 30%.

This simply seems like a business firing on all cylinders. Ellison clearly is confident, and Q2 results suggest he should be.

ORCL Stock Stays Cheap

And yet ORCL is not that expensive in the context of its growth. It trades at a discount to other large-cap software plays. After the Q2 beat, the company should generate over $5 in earnings per share this year, suggesting a price-to-earnings multiple below 17x at the after-hours close.

That multiple exists while at the same time, growth in earnings and free cash flow is likely to accelerate. Oracle has invested heavily across its business, particularly in the infrastructure cloud offering. The capital spending on data spending will slow, helping cash flow. Steadily increasing utilization in infrastructure cloud will boost profit margins.

Indeed, before the report, Wall Street expected a 15% growth in EPS in fiscal 2024. That kind of growth isn’t usually available at a 17x multiple, even in a down market.

What Goes Wrong

In June, I argued that ORCL looked like a safe place to hide in a market then trading at the lows. With both ORCL and the market up since then, there’s a case for ORCL to continue to outperform.

Of course, that broad market sentiment also creates a significant risk. ORCL wound up plunging in September despite a first-quarter report that looked reasonably solid. Tech stocks have rallied since, but it’s far from guaranteed that yet another reversal won’t arrive.

There are idiosyncratic risks as well. Oracle’s earnings are inflated by still-heavy stock-based compensation, which totaled $909 million in Q2, more than 7% of revenue. The exclusion of that spend accounted for roughly a quarter of adjusted EPS; add that expense back, and the FY23 P/E multiple moves toward a less attractive 20x.

Competition isn’t going anywhere, either. Oracle may benefit from signs of trouble at Salesforce (NYSE:CRM), but cloud rivals are everywhere. Oracle’s strategy seems to be working, but pitfalls still loom.

For now, however, Oracle stock still seems worth taking on those risks. Getting a high-performing business at an attractive valuation is what every investor looks for, and it’s exactly what ORCL offers at the moment.

Disclosure: As of this writing, Vince Martin has no positions in any securities mentioned.