Home > Market Commentary > Oracle is Fairly-Valued Following Its Price Correction on 12.21.11

Oracle is Fairly-Valued Following Its Price Correction on 12.21.11

This article presents a financial analysis of Oracle (ORCL), which sold off sharply in the 12.20.11 after-hours session after missing hard on top-line revenue and bottom-line earnings. The analysis shows that this recent price correction has compressed ORCL’s stock to fair value based on a discounted free cash flow model and a slow-growth future trajectory for the company. The stock merits a BUY recommendation at its 12.21.11 closing price of $25.77. Technical analysis indicates negative stock price momentum, however, so even more attractive entry points may lie ahead. ORCL has strong and growing EBITDA/share and NOPAT/share, generates large free cash flows, earns a return on capital well above its cost of capital, and is well-positioned to create value even if future growth downshifts to a new, slower trajectory. I do not expect ORCL’s stock to languish after this revenue/earnings miss like Cisco or Hewlett-Packard. The analysis shows that the company is not broken and can continue creating value in a slow-growth environment. If OCRL follows the MSFT and INTC model, investors will see large dividend increases in the near future, as the company puts more energy into growing dividends to compensate for its slower future growth.

ORCL has a market cap of over $147 billion, posts a return on capital of 15.6% (well above its cost of capital of 9.1%), and had a consensus analysts target price of $36.00 prior to its 12.20.11 price decline.

The stock now yields 0.5%, and its trailing P/E has compressed to a reasonable 14.2 times earnings. As shown below, ORCL creates large and growing economic value-added, and has large and stable free cash flow margins.

ORCL has a beta of 1.19 vs. the Nasdaq-100 index over the past 36 months, a slightly negative annualized alpha due to its higher volatility, respectable institutional ownership, and is one of the most lightly-shorted stocks in the market.

Over the past 2 years ORCL has slightly outperformed the Nasdaq-100 before adjusting for risk:

ORCL’s stock has strongly outperformed peer firms Microsoft (MSFT) and Google over the past 2 years:

ORCL posts strong revenue per share, comparable to a giant revenue producer like MSFT:

ORCL’s trend in EBITDA and EBIT is impressive, growing every year for the past 6 years:

EBITDA per share displays a similar trend, once again comparable with MSFT:

MSFT pulls slightly ahead in terms of EPS, however:

For a dividend-focused investor, MSFT makes more sense:

MSFT now has a respectable yield of 2.6%, vs. ORCL’s yield of 0.5%:

Both companies gross margins have contracted slightly in recent years:

MSFT’s operating margins are also in a slight downtrend, while ORCL’s are more stable in the mid-30% range:

Both firms have strong, stable net margins:

Our process favors stocks whose prices are strongly supported by fundamentals such as Net Operating Profit After Tax. Each companies’ NOPAT/share is shown below. Note the rising trend:

ORCL has invested more in recent years than MSFT, thus their lower FCF/share until the most recent fiscal year (both companies are now in their 2012 fiscal year):

ORCL has a strong ROIC, which only looks small compared with MSFT’s. The spread of each stock’s ROIC over their cost of capital is huge, which is a necessary condition for shareholder value creation:

Both companies create large and growing economic value-added per share.

ORCL has grown its market value-added per share recently due to its stronger stock price performance:

We projected ORCL’s financial statements using a slow-growth scenario that takes growth from 2013-2017 on a declining trajectory, beginning at 4.0% and slumping towards a 2.0% perpetual growth rate. Margins were held at their historical averages in the forecast:

Based on a 5-year beta of 1.09, the current 10-year yield of 1.96%, and a market risk premium of 7.0%, we estimate ORCL’s cost of capital at 9.1%:

A detailed valuation analysis is shown in the table below.

ORCL’s 12.21.11 pre-market price of $26.25 indicates slight undervaluation, based on a DCF fair value price of $27.74:

Technically, the MACD indicates ORCL’s price may drift even lower:

Conclusion: ORCL’s 12.21.11 closing stock price of $25.77  is well-supported by fundamentals and most likely represents a good entry point for the long-term buy-and-hold investor who does NOT require high dividends. Technical analysis indicates negative stock price momentum, however, so even more attractive entry points may lie ahead. The stock has strong and growing EBITDA/share and NOPAT/share, generates large free cash flows, earns a return on capital well above its cost of capital, and is well-positioned to create value even if future growth downshifts to a new, slower trajectory. I do not expect ORCL’s stock to languish after this revenue/earnings miss like Cisco or Hewlett-Packard. The company is not broken and can continue creating value in a slow-growth environment. If OCRL follows the MSFT and INTC model, investors will see large dividend increases in the near future, as the company puts more energy into growing dividends to compensate for its slower future growth.

Datasource: Capital IQ

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