No big surprise here. Slow-growth technology giant Oracle Corporation (NYSE:ORCL) reported mixed quarterly numbers that included revenue and earnings beats, but a weak guide that pointed to slowing growth in the company’s hyper-growth cloud business. In response, Oracle stock dropped 7% to $43.
I’ve never been a big fan of Oracle. The bull thesis has always hinged on out-sized cloud growth propelling the company into a new era of steady growth. But cloud growth has always been weak relative to other major cloud players, and the rest of the business is slowly dying.
Despite those bleak growth prospects, Oracle reached decade highs of over $50 in early 2018.
That didn’t make much sense to me. Now, though, Oracle stock has dropped back closer to $40.
Does Oracle make sense now?
Almost. I peg the fair value of this stock at $40 exactly. Thus, in the lower $40’s, Oracle still seems a tad expensive. But further weakness could be an opportunity.
Here’s a deeper look.
The Oracle Growth Narrative Is Weakening
ORCL stock has staged a big run over the past year because Oracle Cloud has powered improving fundamentals for the company.
The burgeoning cloud business, which has been growing at a 30%-plus clip, has helped transition the entire Oracle company out of the dark ages. For a while, revenue growth had slipped into negative territory and margins were under pressure.
That is no longer the case today. Largely thanks to big growth in Oracle Cloud, revenue growth has inflected into positive territory and margins are marching higher.
The margin expansion part of the turnaround remains healthy today. Operating margins expanded over 100 basis points last quarter to 47%, and have a clear runway for more expansion through cloud revenue growth.
But the revenue growth part of the turnaround is slowing.
In late fiscal 2017 and early 2018, overall revenue growth rates peaked around 4-6%. In the back half of 2018, growth has slowed to 2%, and it is expected to stay there to start fiscal 2019.
In other words, Oracle’s cloud-driven growth narrative is already weakening. The margin expansion part remains promising. But the revenue growth part is crumbling.
That doesn’t imply great things for Oracle stock, which was running higher on hopes that this growth narrative would not just stay strong, but actually get stronger.
That isn’t happening. Now, investors are re-assessing, and the stock is dropping.
Oracle Stock Isn’t Worth More Than $40
Recent weakness in Oracle stock will persist until the price tag is supported by fundamentals. My numbers imply that this floor won’t kick in until $40.
I previously thought this was a 3% revenue growth narrative. But revenue growth has been stubbornly stuck around 2% for two quarters now and is expected to remain there next quarter. Moreover, cloud growth is only slowing, so the chances of revenue growth actually picking up from here are slim.
As such, I peg Oracle as a 2% revenue growth company. The margin expansion narrative through a bigger mix of cloud revenues remains in tact today, and I continue to expect roughly 100 basis points of margin expansion per year over the next five years.
This combination of slow revenue growth and healthy margin expansion leads me to believe that Oracle can do about $4.20 in earnings per share in 5 years. A historically-average 14-times forward multiple on $4.20 implies a four-year forward price target of roughly $59. Discounted back by 10% per year, that equates a present-day value of $40.
Bottom Line on Oracle Stock
The fundamentals are improving for Oracle thanks to robust growth in Oracle Cloud.
But they aren’t improving by that much. Margin expansion is promising, but revenue growth remains anemic and is only slowing. The recent sell-off in Oracle stock more appropriately reflects this low-growth reality. But not entirely. I don’t think shares are fairly valued until $40, and I’m not a buyer until this stock dips back into the $30’s.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.