Will Oracle hold its island and march higher? (Part I)
Oracle Corporation (ORCL) emerged as a focal point for investors following a surprising 13% surge in its share price, a rally sparked by the company's latest earnings release. At first glance, Oracle's financial performance appeared stable, albeit lacking clear justification for the market's enthusiastic response. Yet, upon closer examination of the finer details within the earnings report and the insights offered by Oracle's management, a more nuanced narrative begins to unfold.
In this analysis, we delve into the intricacies of Oracle's financial outcomes, aiming to discern the investment potential that this tech giant presents in the wake of its recent earnings-induced ascent.
Oracle's recent financial performance exceeded expectations, particularly in cloud services and margins, setting a positive outlook for the next quarter, FY25, and beyond, while aligning with its long-term objectives for FY26.
The company is on a trajectory for significant growth, bolstered by stable growth in strategic areas, an increase in Oracle Cloud Infrastructure (OCI) capacity to meet high demand, and a strong market for AI technologies, despite conservative forecasts. This growth momentum is further supported by the anticipated expansion in database services and contributions from Cerner starting in FY25, enhancing the bullish outlook among investors.
Oracle's shift towards cloud computing, strategic capital expenditures in cloud infrastructure, and its robust, low-risk revenue stream position it well to navigate the evolving tech landscape and capitalize on cloud service demands, despite potential short-term impacts on free cash flow and challenges like competitive pressures and demand fluctuations for OCI.
Q3 Recap
Oracle announced its Q3 earnings on Monday, outperforming market predictions and showcasing its strong footing in the AI sector. Despite a cloud growth of 25% slightly missing the anticipated 26%, Oracle's advancements in AI and the successful migration of clients to its Gen2 cloud platform, particularly capturing significant large cap clients, propelled its stock upwards in after-hours trading.
For the fiscal third quarter, Oracle reported revenues of $13.3 billion, with a net income of $4 billion and earnings per share (EPS) of $1.41. Revenue growth of 7.1%, slightly surpassing the consensus estimate of 7.0% and aligning with the guidance range of 6-8%.
The company's performance in cloud services and support exceeded expectations with an 11% growth, while license revenues also outperformed forecasts, showing a decrease of 3.0%, which was better than anticipated. Operating margins were notably higher than expected, at 43.6% compared to the consensus of 43.1%, and earnings per share (EPS) were 3 cents above forecasts.
Cloud revenue growth was the 25%, totaling $5.1 billion, from its Infrastructure-as-a-Service (IaaS) and Software-as-a-Service (SaaS) offerings. Cloud Infrastructure revenues soared by 49% to $1.8 billion, and Cloud Application revenues grew by 14% to $3.3 billion.
Further underscoring Oracle's cloud dominance, its Fusion Cloud ERP and NetSuite Cloud ERP products saw revenues grow by 18% and 21% respectively, cementing its leadership in the ERP market. Oracle's CEO, Safra Catz, highlighted a significant 29% increase in Total Remaining Performance Obligations, reaching a record $80 billion, with expectations to recognize 43% as revenue in the next four quarters (Approximately $33-35 billion). This growth was driven by a surge in new cloud infrastructure contracts, fueled by high demand for Oracle's Gen2 AI infrastructure.
For the upcoming fourth quarter, Oracle provided revenue guidance of 4-6% year-over-year (y/y) growth reported, slightly below the consensus of 6.5%, and 6-8% growth y/y excluding Cerner's impact.with cloud revenue expected to rise by 22-24%, excluding Cerner.
Key positives from the report include:
- A 29% y/y increase in Remaining Performance Obligations (RPO) to $80 billion, a significant acceleration from the 1% growth seen in the previous quarter.
- Oracle Cloud Infrastructure (OCI) growth of 52% y/y, suggesting a substantial increase in sequential dollar adds, likely exceeding many buy-side expectations.
- A forecasted capital expenditure (capex) for FY25 of around $10 billion, indicating a substantial increase from the $7-7.5 billion guidance for FY24.
However, there were some concerns:
- Q4 revenue guidance of 4-6% y/y was slightly below the consensus estimate of around 6.5% y/y.
- The growth of Fusion Cloud ERP at 18% y/y in ccy was marginally below the 19% seen in the last quarter.
- Cerner represented a roughly 2% headwind on total revenue y/y growth for the quarter and is expected to be a similar headwind in the next quarter.
Following the earnings release, Oracle's shares experienced a more than 12% jump in after-hours trading, building on a 34% increase over the past year. Oracle's Q3 earnings reflect its position in the AI market and an optimistic outlook on healthcare expansion, with ongoing efforts to scale its cloud infrastructure and data centers to meet the soaring demand for its AI solutions.
Overall, Oracle's earnings illustrate solid growth and operational efficiency, with strong cloud services performance and strategic capital expenditure plans signaling optimism for future growth, despite some areas of softness and external pressures from Cerner's integration.
Q3 Thoughts
Despite a seemingly uneventful Q3 at first glance and slightly conservative guidance for Q4, the real excitement lies in the capacity expansion driven by these Capex investments. The report showcased robust growth in applications and infrastructure, capturing investor attention with significant capital expenditures for both the quarter ($2.1 billion) and the forecast for FY25 ($10 billion), indicating strong future cloud growth.This, combined with ongoing customer demand—as highlighted by robust Remaining Performance Obligations (RPO) growth—points to a promising future for Oracle.
The company's performance and positive outlook alleviated some growth concerns that emerged over the past few quarters. In comparison to other software vendors' recent results, Oracle's achievements underscore the resilience and robustness of its business. It's crucial to acknowledge Oracle's focus on cloud services, particularly its Oracle Cloud Infrastructure (OCI) Gen 2, as the cornerstone of discussions about the company's strategy and growth prospects.
Oracle's performance against modest expectations included revenue broadly in line with consensus, with strength in Infrastructure-as-a-Service (IaaS) balancing out softer Software-as-a-Service (SaaS) results. Despite a slight decline in gross margins, profitability exceeded expectations with an EBIT margin roughly 100 basis points ahead. The quarter's standout was the bookings, with current RPO growing 16% year-over-year (compared to the previous quarter's 7%) and calculated current RPO bookings surging 29% year-over-year—an improvement from the last quarter's 6% growth.
While the after-hours stock rise reflects strong bookings, management's optimistic press release mentions enduring hypergrowth trends in Gen 2 IaaS, with demand far outstripping supply. The short-term outlook for Capex fell short of expectations, however, investors were willing to look past that and focus on the long-term projections which suggested the company sees a runway to push it to expand facilities to deal with demands. The company also noted that it was not having a problem acquiring GPUs to meet demand and hinted at a partnership with AI darling Nividia (NVDA).