Oracle (ORCL) reported Q4 revenue that was below expectations and is consistent with its recent profile of minimal growth. Revenue actually declined by 4% during the quarter in constant currency terms, and while this was likely impacted a little bit by the global pandemic, underlying trends have been mixed for quite some time. However, better-than-expected margins along with share repurchases led to EPS beating expectations.
Management provided Q1 revenue guidance of 0-2% on a constant currency basis, which would be an improvement from the most recent quarter despite the pandemic continuing to impact results. In addition, management talked about their confidence of revenue growth actually accelerating once we get past the pandemic and enterprises resume their normal enterprise spending.
Oracle remains one of the largest legacy technology players in the market and has been experiencing some growing pains over the past several quarters. Immediately after reporting earnings, the stock fell over 5% as investors absorbed another quarter of revenue decline. However, management’s commentary about future revenue growth acceleration sparked a small rebound.
Its valuation continues to remain below that of other legacy technology companies, and I believe the biggest reason why is the inconsistent and slow revenue growth. Even though Oracle has talked about its revenue growth accelerating over the past several quarters, investors have yet to see this trend begin. While I don’t see valuation going much lower than current levels given the company’s consistent cash flow generation, I remain on the sidelines for now until there is better visibility into the next catalyst to drive the company forward.
What could be the next catalyst? Management has talked about the company’s client relationships broadening, which can ultimately accelerate revenue growth in the future. During the recent quarter, they noted the global pandemic has put this acceleration path on hold for a few months, though this has caused Oracle’s customers to realize their need for more modern technology. The company’s cloud services revenue stream grew 4% during the quarter and represented ~65% of the overall revenue, and as the mix of revenue continues to turn favorably as the declining revenue streams become less of overall revenue, Oracle may be on the path towards revenue improvement.
Q4 Earnings and Guidance
Similar to the past several quarters, Oracle has struggled to produce positive revenue growth. During the quarter, revenue declined by 4% on a constant currency basis to $10.44 billion, which was below expectations for ~$10.70 billion. While the company is above the $40 billion run-rate revenue mark, it has struggled to generate substantial positive revenue growth, which continues to be an overhang on the stock.
Cloud services and license support revenue has been the only consistent bright spot in revenue over the past several quarters. During Q4, this revenue stream grew 3% on a constant currency basis and represented ~65% of total revenue. While this is a solid growth figure for ~65% of the business, the rest of the company continues to experience decline. Not surprisingly, hardware revenue declined by 7% on a constant currency basis, which follows the trend of enterprises investing more in software solutions rather than legacy hardware and on-premise solutions.
(Source: Company Presentation)
The biggest detractor during the quarter was cloud license and on-premise license revenue, which declined 21% on a constant currency basis. Similar to hardware revenue, enterprises are moving away from licenses. With a license, an enterprise pays a large upfront cost and owns the technology. However, subscription revenue is taking over license revenue, as enterprises pay a much lower monthly fee and receive software updates from the selling company. In other words, rather than paying several hundred dollars upfront for your Netflix account, consumers are much more willing to pay $10-15 a month to receive the updated services.
(Source: Company Presentation)
Investors understand and have accepted that Oracle is not going to return to 10%+ revenue growth, and given its maturity, the company has been very consistent at generating free cash flow. During the quarter, non-GAAP operating margins came in at 49.2%, up from 47.2% in the year-ago period. I think this positively surprised investors, as it is challenging for more mature companies to achieve significant margin expansion.
The strong margins led to free cash flow conversion of 114% during the quarter, which is consistent with the previous four-quarter range of 111-116%. Having this strong, consistent cash flow is likely preventing the stock from reaching low valuation levels. Investors have to weigh many factors when determining a company’s valuation, and given Oracle’s consistently strong free cash flow, it makes it challenging to place a low valuation on the company.
While revenue growth during the quarter disappointed, the company’s better-than-expected margins led to EPS of $1.20 during the quarter, above expectations for $1.15.
Management declined to provide guidance for FY21 given the many uncertainties surrounding the global pandemic, however, Oracle did shed some light on its first quarter of the year. For Q1, the company expects revenue to grow 0-2% on a constant current basis. In addition, it is expecting EPS to be $0.85-0.89, which represents 5-9% constant currency growth. Essentially, this means the company will continue to use a combination of operating leverage and share repurchases to grow their bottom line more than their top line.
In addition, management noted they continue to have confidence that revenue growth will accelerate once we move beyond the global pandemic.
While Oracle was initially down over 5% after earnings, the stock has since recovered and is only down 1-2%. It seems like the initial downward movement was due to revenue growth remaining low and the company not providing full-year guidance. The global pandemic has caused significant forecasting challenges, and companies should be given a pass for not being able to provide forward guidance.
Even though full-year guidance was not provided, management did provide some commentary about their beliefs of revenue growth accelerating post pandemic. Oracle’s cloud products seem to be gaining traction with its customers, and as legacy revenue streams continue to decline and represent less of overall revenue, the stronger growth revenue business has the potential to lead the company to a growth trajectory.
Historically, legacy technology companies have focused on selling hardware products, and many of the above peer group continues to sell hardware. However, as enterprises embrace the cloud, the transition to more software-based revenue streams has been essential to operating a successful business. Nevertheless, these legacy technology companies tend to grow at much lower rates than pure software companies, thus their valuations are better determined based on P/E or EBITDA.
Oracle has consistently seen its hardware revenues decline, however, its cloud revenue has performed rather well, as these products have strong demand in the marketplace. Given the company’s long history of generating consistent margins and cash flow, investors have historically used P/E and EBTIDA multiples to determine valuation.
Currently, Oracle trades at ~13.2x forward P/E and ~10.1x forward EBITDA, which are both at the low-end of the above peer group. I believe valuation continues to be at the low end due to the company’s consistently low revenue growth profile. While trends have been improving and management remains confident in revenue accelerating, investors still need to see this trend before the valuation reflects this.
For now, while I believe the company will remain successful over the long-term, I remain on the sidelines. Until the company is better able to demonstrate revenue growth accelerating, I find it challenging for the company’s valuation multiples to improve from current levels.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.