My Call on Oracle: Blue Skies Ahead in the Cloud

 | Sep 12, 2017 | 10:00 AM EDT
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This Thursday, Sept. 14, Oracle Corp. (ORCL) reports earnings for its fiscal first quarter, which ended Aug. 31. Are there storm clouds on the horizon?

I have been bullish on shares of Oracle all year. Back in December, I thought the company was finally serious about the cloud.

Then in June, after a blow-out quarter, I thought the stock could continue to reach for the clouds.

Year to date, the stock is up 36.5%.

Customers are transitioning away from the traditional software-licensing model toward a cloud service model and it shows in Oracle's results. Sales in fiscal 2016 were down 3.1% to $37 billion as the company struggled to move customers to the cloud. License growth slowed to a crawl. The stock was down 2% last year. But by the third quarter of fiscal 2017 Oracle hit an inflection point. Cloud service revenue began to contribute to earnings. This year, that trend only is expected to get stronger.

Analysts are looking for Oracle to report earnings in the quarter of $0.61 per share on $9.03 billion in revenue. Revenue is expected to be up 4.8% this quarter and should grow 4% to 4.5% each quarter as cloud revenue accelerates. Total cloud revenue should be up more than 50% this quarter to $1.4 billion. While customers transition to the cloud, new software license revenue is expected to be down 14% to $5 billion.

The shift to the cloud has positive implications for gross margins as well. Last year, cloud margins were below 60% and weighed down the company's overall margin. But this year, cloud margins are expected to pick up as Oracle gains leverage over its expensive cloud build-out. I am looking for cloud margins to be 61% this quarter and to improve throughout the fiscal year that ends next May 31. By the end of the year, Oracle should be able to get cloud margins into the mid-60s.

By keeping a tight lid on expenses, operating margins could pop 100 basis points this quarter to 40.5%, which means net income finally will show some growth. Analysts are modeling net income up 10.5% to $2.5 billion. In the past Oracle has had a hard time showing any net income growth. Recall that adjusted net income fell 10% in fiscal 2016 and was up only 2.9% last year.

Add it all up and Oracle has the right stuff to beat Street estimates all year. The consensus estimate for fiscal 2018 is $2.95 a share, which seems low to me. Oracle should be able to beat each quarter consistently and guide earnings up for the rest of the year even with modest single-digit revenue growth of 4% for the year. The high-end analyst estimate of $3.05 a share definitely looks achievable. If Oracle can pull it off, the momentum should carry this stock into the mid-$60s, or about 21 times estimates.

In my opinion, there are no storm clouds on the horizon for Oracle. It looks like nothing but blue sky.

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