Oracle (ORCL) released second quarter FY2015 earnings last night after market close, and while those of you who have followed me for a few years know I am not one to pay much attention to these things, there were a few points that stood out.
Two points, in particular, to which I pay close attention are revenue growth (since revenue growth is a proxy for customer demand) and Owners’ Cash Profit [1]. These measures look strong and phenomenally strong, respectively, in the most recent quarterly report.
Revenues
Revenues showed year-over-year mid-single digit growth, as the company reported in its announcement:
Oracle Corporation today announced that fiscal 2015 Q2 Total Revenues were up 3% to $9.6 billion. Software and Cloud Revenues was up 5% to $7.3 billion. Cloud software-as-a-service (SaaS), platform-as-a-service (PaaS) and infrastructure-as-a-service (IaaS) revenue was up 45% to $516 million. Hardware Systems revenues were up 1% to $1.3 billion.
Looking at revenues on what is called a “constant currency” basis–which ignores foreign currency fluctuations–growth was 5% on a year-over-year basis. The constant currency figure is probably the more important to figure at which to look, as it more accurately shows the strength of demand for the company’s products and services.
In comparison, IOI’s most recent valuation for the company projects a worst-case revenue growth over the next five years of 4% per year and a best-case revenue growth of 6% per year. As such, the most recent actual results on a constant currency basis are precisely in the middle of our best- and worst-case range.
While many’s eyes will be drawn to the “45%” increase mentioned in the announcement above, the number I was happiest to see was the 1% increase in Hardware Systems revenues.
As those of you who watched my recent webcast analyzing Oracle’s business, after acquiring Sun Microsystems in 2010, Oracle began winding down Sun’s noncompetitive server lines. This product paring, while necessary, has proven to be a severe headwind to Oracle’s revenue growth over the past several years.
While the 1% Hardware Systems growth does not look very impressive versus the growth recorded the (much smaller) SaaS and PaaS segment, the very fact of the hardware segment revenue growth suggests this business may have reached an important inversion point. If so, at last, the Hardware segment will add, rather than detract from Oracle’s revenue growth for a change.
Profits
In the above-mentioned webcast, I point out the impressive stair-stepping of profit margin generated by the firm despite the low revenue growth environment. Analyzing Oracle over the past few years, I had come to the conclusion that while this profitability increase was impressive, Oracle’s maximum OCP margin was unlikely to settle much higher than the current mid-30% range.
The most recent IOI valuation model projects an average worst-case OCP profit margin of 32% over the next five years, ad a best-case margin of 36% over the same period. In contrast, during the first six months of FY2015, Oracle generated Owners’ Cash Profits of $7,457 million on revenues of $18,194 million for a margin of 41%–500 basis points above my best-case average.
IOI best- and worst-case scenarios are not based on a single quarter’s worth of data–which might be affected by temporary factors–but represent an average over a period of several years. Still the difference between my best-case assumption and this quarter’s results have convinced me that I should at least consider the possibility that my best-case profitability assumption is too low.
I am planing a follow-up webcast using the IOI Tools site updating my valuation of Oracle as shown in the IOI Tear Sheet on the company published in November. In that video, I’ll take a look at what happens to the valuation if a higher best-case profitability assumption is made.
NOTE:
[1] Owners’ Cash Profit is a cash-centric measure of profitability discussed fully in The Framework Investing and in the and in the online web appendices on the IOI Website.