We are downgrading Oracle Corporation (NYSE:ORCL) on hold. The stock is up 77% since our Buy recommendation at the end of September last year and has outperformed the S&P 500 (SP500) by almost 60%. We expect the stock to have risen since late 1H23 as investors got too excited about Oracle’s growth potential in the artificial intelligence (“AI”) space. We have driven the AI momentum higher and now expect the outperformance to weaken further in the second half of 2023. We believe investors would be better positioned in the near term to stand on the sidelines.
The table below shows our initial buy recommendation for the stock in September.
While we believe Oracle is well-positioned to be relatively resilient, we expect near-term headwinds to weigh on the stock and we will see more attractive entry points during pullbacks through 2024.
Softer spending environment
We see further near-term challenges to Oracle’s revenue growth due to macroeconomic headwinds weighing on corporate, service provider and government spending in the near term. Oracle’s key customers are experiencing lower cloud spending due to the higher interest rate environment, and we expect this to impact Oracle as well. Microsoft’s (MSFT) Azure growth last quarter was a clear signal of the state of the current spending environment, with Azure growth slowing sequentially. While we like Oracle’s market position, we believe the company has been overvalued in AI and will now slowly give up AI gains as AI tailwinds do not offset macro weakness given limited cloud investments in 2023 can. We believe that corporate spending is still in the optimization cycle; We now expect that corporate spending will increase again in the first half of 2024. However, in the near term, we expect macroeconomic weakness to weigh on Oracle’s cloud services and license support segment, which accounts for 77% of total revenue. In the first quarter of fiscal 2024, cloud services and license support increased 13% year-over-year, compared to 23% year-over-year growth. We expect the segment to experience a growth plateau by 2024.
Year-to-date, Oracle is up nearly 30% and has outperformed the S&P 500 by as much as 17%. Over six months, Oracle is up 13% while the S&P 500 is up 4%; Oracle outperformed by 9%. We believe the outperformance is now tapering off and macroeconomic weakness is priced into the stock and outlook. The stock took a steep turnaround in September, falling about 12% on management’s lower guidance.
We believe Cerner will also be a headwind to revenue growth in the near term. At Cerner, management forecasts total revenue between 3-5% at constant exchange rates and 5-7% in USD at today’s rate; Excluding Cerner, revenue growth is expected to be 7-8% year over year in constant currencies and 8-10% in USD terms. Total cloud revenue, excluding Cerner, is expected to grow 27-29% in constant currency and 29-31% in USD terms. We believe Cerner’s transition from license to cloud creates near-term headwinds to revenue growth. We recommend that investors stay on the safe side in the short term.
Oracle’s enterprise-to-value ratio for CY24 is 6.7x, slightly below the peer group average of 7.01x. In terms of price-earnings ratio, Oracle is trading at 18.3x for CY24, well below the peer group’s 74.6x. While we believe Oracle is undervalued relative to its peers, we do not currently see a near-term catalyst that would lead to outperformance. Therefore, we do not see a favorable risk-reward profile in the short term. The following graphic shows ORCL’s rating compared to the peer group.
Word on Wall Street
Wall Street is divided when it comes to its view of Oracle. Of the 34 analysts covering the stock, 17 have a “buy” rating and 16 have a “hold” rating. The stock is currently trading at around $109. Using the median price target of $133, we calculate an upside potential of 22% and an upside potential of 21% using the median price target of $131. The chart below shows Wall Street sentiment toward the stock.
What to do with the stock?
We downgrade Oracle Corporation to Hold as we anticipate further downside risks in the near term and expect further weakening of AI-driven outperformance. We expect Oracle’s revenue growth to face obstacles as corporate, service provider and government spending slow in the current high interest rate environment. Cerner’s shift in revenue to cloud services will also continue to weigh on near-term growth. We expect Oracle to outperform in the medium to long term, but see more risks in the short term. We recommend investors stay on the sidelines in the second half of 2023.
Source : seekingalpha.com