Oracle’s Cloud Business Solid; CEO Hurd Taking Some Time Off

Oracle’s strong Dividend Cushion ratio reflects considerable free cash flow generation in excess of cash dividends paid. Fiscal first quarter free cash flow of $5.6 billion covered cash dividends paid of $795 million more than 7 times.

By Brian Nelson, CFA

On September 11, Dividend Growth Newsletter portfolio holding Oracle (ORCL) posted solid fiscal first-quarter 2020 results (ends August 31), but the company’s results were overshadowed by a slight revenue miss on the top line and news that CEO Mark Hurd would take a leave of absence; we wish him a speedy return to good health. Co-CEO Safra Catz and founder Larry Ellison will cover his responsibilities while away. Oracle remains in good hands.

Oracle’s total revenue advanced 2% in constant currency during the period, while GAAP operating income increased 4%. GAAP earnings per share advanced 11%, to $0.63, coming in a penny better than the consensus forecast. Internals were solid: short-term deferred revenue was $10.1 billion at quarter-end, while operating cash flow during the trailing twelve months came in at $13.8 billion (free cash flow during the same period was $12.2 billion).

Image Source: Oracle fiscal first-quarter press release

During the quarter, non-GAAP earnings per share advanced 16% in constant currency, and Oracle continues to aggressively grow its higher-margin cloud business. Its cloud ERP businesses grew a solid 33% in the quarter, and the firm noted that it now has over 6,500 Fusion ERP (enterprise resource planning) customers and over 18,000 NetSuite ERP customers.* Oracle retains the “number one market leader position in cloud ERP worldwide.” Here’s what the firm said about its outlook for the cloud; from the conference call:

As you’re already aware, our back-office applications business has been reporting excellent growth for a number of quarters now. And we have a massive opportunity ahead of us in both ERP and HCM (human capital management). Not only do we have an enormous installed base of existing ERP and HCM customers, who can operate to the cloud, but more than half of the current ERP and HCM market is served by companies, who have no SaaS upgrade path. These companies’ products are vulnerable to being replaced, and we’re in the process of replacing them.

Our investments in Fusion has not only enabled our strong back-office results over the last few years, but they’ve positioned us to become not just the biggest back-office player in the cloud, which we already are but the biggest back-office player period. Cloud on-premises all of it.

Oracle closed the quarter ending August 31 with $35.7 billion in cash and marketable securities and $54.4 billion in total debt, so the firm retains a very healthy balance sheet, despite a large debt position. Free cash flow has faced some tough comparisons on a rolling twelve-month basis, but Oracle remains one of the best free-cash-flow generators on the market today. The company’s cloud business requires minimal capital investment, with capital expenditures ~10%-12% of operating cash flow (more recently, on a trailing twelve-month basis, capital spending has generally hovered in the $1.6-$1.7 billion range).

Concluding Thoughts

We see no reason to make any material changes to our fair value estimate as a result of the quarterly report; shares are trading roughly in-line with our $55 fair value estimate at the time of this writing. As such, we’re neutral on the firm’s decision to increase its buyback program by $15 billion. During the past 5 years, Oracle has reduced its share count by more than 25%, with most of the buybacks completed in value-generating territory (below our fair value estimate). The firm’s outlook remains solid; what management had to say on the conference call:

Assuming, current exchange rates remain the same as they are now, currency should have a 1% negative effect on total revenue and $0.01 negative on EPS. Of course, that could change. So, for Q2, total revenues are expected to grow 1% to 3% in constant currency. And assuming a 1% currency headwind, total revenues are expected to grow from 0% to 2% in U.S. dollars.

Non-GAAP EPS in constant currency is expected to grow between 10% to 12% and be between $0.88 and $0.90 in constant currency. And assuming the $0.01 headwind, non-GAAP EPS in U.S. dollars is expected to grow between 9% and 11% and be between US$0.87 and US$0.89.

For fiscal 2020 and the third consecutive fiscal quarter, I expect that we will report double-digit EPS growth in constant currency. Total capital spending for fiscal year 2020 is expected to be around $2.2 billion, but it could move a little depending on our bookings, and how much we need to invest to accommodate them.

The company’s strong Dividend Cushion ratio reflects considerable free cash flow generation in excess of cash dividends paid. Fiscal first quarter free cash flow of $5.6 billion covered cash dividends paid of $795 million more than 7 times. Though capital spending will come in a bit higher than years past during 2020 (~$2.2 billion), Oracle retains significant financial capacity via free-cash-flow generation to grow its dividend, and that’s why it remains in the Dividend Growth Newsletter portfolio. Shares yield ~1.7% at the time of this writing.

* “Oracle Cloud SaaS offerings include, among others: Oracle ERP Cloud, which is designed to be a complete, global and integrated ERP solution to help organizations improve decision making and workforce productivity, and to optimize back-office operations by utilizing a single data and security model with a common user interface. (Oracle) also offer(s) NetSuite ERP, which is a cloud-based ERP product that is generally marketed to small to medium-sized organizations and is designed to run back-office operations and financial processes and includes financial management, revenue management and billing, inventory, supply chain and warehouse management capabilities, among others; Oracle HCM Cloud, which is designed to help organizations find, develop and retain their talent, enable collaboration, provide complete workforce insights, improve business process efficiency, and enable users to connect to an integrated suite of HCM applications from any device (source).”