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Posts Tagged ‘discounted cash flow model’

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

Kinder-Morgan Energy (KMP) Represents Better Value for Dividend-Focused Investors Compared With Williams Companies (WMB)

The analysts at Sabrient had a Strong Buy recommendation on natural gas energy producer Williams Companies (ticker WMB) on Dec. 5. This rating was reduced to a Buy recommendation on Dec. 12 (report available here). Sabrient likes Williams’ price momentum and recent earnings increases. Additionally, the company has raised their annual dividend for 5 straight years, which is a strong vote of confidence regarding the sustainability of these higher earnings.

This article will take a closer look at Williams from the point of view of a fundamentals-oriented, dividend-focused investor. Our bottom-line conclusion is that Williams is inferior to alternative stocks such as Kinder-Morgan Energy Partners (KMP). The analysis below shows that KMP has stronger per share fundamentals, a higher dividend yield, a lower beta (thus a lower cost of capital), and better per-share valuation based on a discounted cash flow model. Williams’ return on capital is well below its cost of capital, which makes it a persistent value-destroyer. (Click on the link to download our one-page summary: WMB).

Below we see that WMB’s stock is up 70% in the past 2 years, handily beating rival firms like KMP and Anadarko Petroleum (APC):

The stock also outperformed the S&P 500 over the same period:

WMB’s total revenue continues recovering from its 2009 lows; the company’s profits are also recovering:

WMB’s EBITDA and EBIT display a solid uptrend since 2009:

Notice that WMB’s revenue per share remains depressed, and much lower than Kinder-Morgan’s:

The trend in WMB’s EBITDA/share is largely flat. Although KMP generates greater EBITDA/share, KMP’s EBITDA/share is in a 4-year downtrend:

While Sabrient’s analysts are correct in their assertion that WMB’s earnings have shown a nice recovery, especially compared to KMP, also notice the much higher volatility of WMB’s EPS (which explains much of the beta-differential between the two companies; WMB’s beta is 1.32, vs. only 0.37 for KMB):

While both firms managed to increase dividends each year for the past 5 years, KMP absolutely trounces WMB in terms of dividends per share:

KMP also has superior operating margins:

and net margins:

Given the trend in natural gas prices, we don’t expect margin expansion for either company any time soon:

While both stock’s dividend yields are trending downward, KMP’s yield of 5.8% is almost 3 times larger than WMB’s yield of 2.1%:

KMP is also superior in terms of return on invested capital:

and free cash flow per share:

Which explains why WMB keeps falling behind in terms of economic value-added per share:

and market value-added per share:

With small per share fundamentals and a high cost of capital due to their high beta, WMB measures up as extremely over-valued based on a discounted free cash flow model:

But KMP measures up as significantly under-valued due to their larger per share fundamentals and lower cost of capital:

Conclusion: With greater per-share fundamentals and ROIC, a stronger track record of value creation, a much higher dividend yield and a far lower beta, Kinder-Morgan Energy Partners (KMP) represents a better value for a fundamentals-oriented, dividend-focused investor than Williams Companies (WMB).

Datasource: Standard & Poor’s Capital IQ