Three months ago, Oracle Corp.’s scorching earnings outlook sent the shares soaring to their best day in three decades. But a quarter later, things look very different for the database software maker and the AI trade in general.
TL;DR
- Oracle's stock declined 33% since its September peak due to AI sector doubts and high investment.
- Investors worry about Oracle's debt, negative free cash flow, and customer concentration.
- Analysts expect Oracle's order book to grow, but concerns about financing and AI partnerships remain.
- Oracle's stock valuation is high, and investors await clear margin improvement and execution.
Oracle's stock, scheduled to release its financial results after market hours, has seen a 33% decline since September 10th, a date marking its peak valuation driven by excitement over its booming cloud operations. Currently, Oracle, alongside numerous other firms in the artificial intelligence sector, is encountering widespread doubt owing to substantial investment outlays and the self-referential structure of certain agreements.
Argent Capital Management, a holder of Oracle stock, had its portfolio manager, Jed Ellerbroek, state, “They are stretching their balance sheet about as far as they can, their free cash flow is negative and their balance sheet is highly levered,”. “Their neck is sticking out.”
Oracle’s debt risk is particularly troubling to investors. The company has sold tens of billions of dollars of bonds in recent months through note sales in its name and indirectly through projects it’s backing. Last week, the cost of protecting Oracle’s debt against default reached its highest level since March 2009. Analysts following the company say this uncertainty dwarfs whatever good news it reports in its quarterly earnings.
“It won’t matter as much as the overarching story of customer concentration, how are they financing all this?” Gabelli Funds analyst Ryuta Makino said. “They’re going to be free cash flow negative for the next couple of years during the data center build out. So there’s a lot of question marks surrounding that.”
Oracle made no statement. The stock saw minimal movement after a decline of 1.2% during initial trading on Wednesday.
Analysts on Wall Street anticipate that the Austin-based firm's order book will expand during its fiscal second quarter, concluding in November. The outstanding contract commitments, a metric that ignited the surge in late September, are forecasted to reach approximately $520 billion, representing an increase exceeding 400% compared to the previous year, and are expected to continue their upward trend in the subsequent quarter, based on information gathered by Bloomberg.
Perception Problem
Michael Sansoterra, chief investment officer at Silvant Capital Management, whose holdings include Oracle, stated, "“It’s not about the growth rate as much as it is the perception of how they’re getting there,”". “I don’t know that earnings will change the picture. I suspect the quarter will be good, and I suspect the guidance will be good.”
Experts project that Oracle's adjusted earnings per share will increase by 11% compared to the same period last year, with revenue climbing 15%, based on information gathered by Bloomberg. The firm's gross margin is anticipated to be close to 69%, a decrease from 71% in the prior year. A significant shift is observed in its capital spending, forecast at $8.2 billion, contrasting with under $4 billion a year ago, and its free cash flow, which is estimated at -$5.9 billion, an improvement from $2.7 billion in the preceding year.
During the financial results discussion, Oracle's leadership will undoubtedly face inquiries regarding OpenAI, a company that entered into a substantial agreement with Oracle for cloud infrastructure solutions back in September. Shareholders are eager to understand the variety of Oracle's anticipated income streams, and any major new clients secured throughout the reporting period will likely be met with enthusiasm.
“I always thought it was dangerous for the company to take on significant leverage while tying its future to a startup. Now that OpenAI is under siege, the risk has elevated even further,” said Michael O’Rourke, chief market strategist at Jonestrading. “It will be imperative for management to present a contingency plan if OpenAI is slow or unable to execute.”
Irrespective of the outcome, participants in options trading anticipate a shift in Oracle's share value following the announcement, factoring in a potential 10% surge in either direction post-earnings. The stock has seen a recent recovery, climbing nearly 10% during December.
Regarding their worth, the stock appears somewhat pricey, changing hands at approximately 30 times projections for earnings in the coming year, a figure significantly exceeding its decade-long average of 17 and surpassing the Nasdaq 100 Index's 26 multiple.
This situation has caused some investors to be reluctant about purchasing Oracle shares at this moment. Sansoterra, representing Silvant Capital, has stated that he is currently in a waiting phase.
“If we saw margin improvement or margin trajectory that was not just talk but actual execution, we’d be more interested,” he said. “But we haven’t seen that yet. And we don’t do the hope trade.”
Cisco Systems Inc. Stock has seen a surge of approximately 34% in the current year, approaching its record peak from the year 2000. Shareholders have anticipated this point for over a quarter of a century, with the company's shares trading at valuations reminiscent of the dot-com boom's zenith.
