Oracle (ORCL) FQ2 Preview

by riskreversal December 15, 2016 11:00 am • Trade Ideas

Event: Oracle (ORCL) reports fiscal Q2 results tonight after the close. The options market is implying about a 4% one day post earnings move in either direction tomorrow, which is basically in line with its 4 qtr average one day move. with the stock near $41, the Dec 16th weekly (tomo) 41 straddle (the call premium + the put premium) is offered at $1.64, if you bought that and thus the implied move you would need a rally above $42.64, or a decline below $39.36 to just break-even by tomorrow’s close.

Price Action / Technicals: Shares of ORCL are surprisingly up (12.5%) on the year in line with gains of Microsoft (MSFT) and Adobe (ADBE), out-performing the Nasdaq up 9%, and cloud software peers (CRM) which is down 9%, ServiceNow (NOW) down 8% and Workday (WDAY) down 13%.

The stock sold off two weeks ago following the worse than expected results and guidance from WDAY, but has since come roaring back bouncing off of technical support at $38 and quickly approaching resistance that dates back to March at $42:

[caption id="attachment_68958" align="aligncenter" width="600"] ORCL 1yr chart from Bloomberg[/caption]

Taking a longer term view, the stock was rejected in late 2014, just near its 2000 high, serving as an epic double top?? While the uptrend that has been in place from the 2009 lows was breached earlier this year, with $35 the likely next stop on any meaningful sell-off:

[caption id="attachment_68959" align="aligncenter" width="600"] ORCL since 1999 from Bloomberg[/caption]

Estimates and Forecasts from Bloomberg:

-FY2Q adj. EPS est. 60c (range 58c-62c)
-FY2Q rev. est. $9.12b (range $8.98b-$9.36b)
-FY3Q adj. EPS est. 64c
-FY3Q rev. est. $9.24b
-ORCL gave 2Q forecast in constant-currency terms, which typically doesn’t compare w/ ests Oracle Sees 2Q Adj. EPS 59c-62c in Constant Currency

Expectations…. most importantly, investors need to see a continuation of cloud based sales growth during their transition from legacy “on-premise” applications. Here is Nomura analyst Fred Grieb on his expectations for ORCL’s cloud business from a note to clients last week:

Material acceleration in cloud growth to continue in F2Q’17
We have noted that as more contracted deals go live and burn through their free promotional periods, we may see acceleration in the billings and revenue metrics. Oracle confidently expects this coincidence of billings (or completion of promotional periods) to continue in F2Q’17, following strong cloud SaaS/PaaS growth of 80% in F1Q’17. During F1Q’17 earnings, management increased guidance for SaaS/PaaS revenue growth to 78-82% (cc) in F2Q’17.

Oracle also expects SaaS/PaaS gross margins to improve in F2Q’17. The company maintains its 80% gross margin target over time, based on the expectation for increased cloud revenue and moderating investments in cloud capex.

Cloud adoption is important, but license revenue declines will also remain a focus
As Oracle transitions its business to the cloud, it will be important to make sure that the company is not losing share to the competition. Strong cloud growth rates support the business transition; however, the steep license revenue declines in recent quarters have created concerns that the company may not be successfully converting on-premise customers to the cloud. Investors seem to be concerned that Oracle is not only cannibalizing the on-premise license business, but that it is also offering aggressive incentives to sign cloud customers.

The recently completion of their NetSuite acquisition will be a focus on the call, despite the recent strategy update and the fact the deal will be accretive, some analyst feel the deal will be a drag on margins.

Our Take into the Print:  55% of ORCL’s sales come from outside the U.S.  The U.S. dollar’s recent breakout to new 13 year highs, with the U.S. dollar index (DXY) up nearly 8% since the company last gave guidance in mid September, means you could expect headline results and guidance to be below expectations.  While ORCL would certainly benefit from a tax holiday, it’s important to note that they have funded much of their acquisition binge of the last decade with debt. They now have $14 billion in net debt ($68.4 billion in cash, and $54 billion in debt).

ORCL trades a tad below a market multiple, which makes sense when you consider analysts see flat eps and sales growth in the current fiscal year and their continued need for large acquisitions to merely keep from showing annual declines weighed down from legacy businesses.

An unexpected beat and raise and the stock is through resistance at $42 and on its way back towards the 2014 high in short order. I place that at less than a 25% probability.

An unexpected miss and guide down and the stock is on its way back to the 2016 recent support near $38. I place that at about a 25% probability.

The most likely outcome in my opinion is that the stock is up or down about $1 -$2, but likely skewed to the downside. We’ll follow up with some trade ideas for those long the stock, and who want to be long the stock with defined risk.