Author: Andy Djordjalian
Covestor models: South America, Emerging Market Sector Focus
Shares of Oracle Corp. (ORCL) dropped about 12% on Wednesday (12/21) after the company released sales and profit figures below guidance and analysts’ estimates for the quarter that ended in November, plus reduced guidance for the current quarter. Tech stocks were dragged down as investors interpreted Oracle’s news as a sign of a sharper-than-expected slowdown of business conditions for the sector.
I hold Oracle in my Emerging Market Sector Focus Model, a leveraged long-only model where I combine emerging markets, resources and technology stocks. When news like these emerge for a company that I am holding, I reassess my thesis regarding the potential of the stock and its role in my portfolio. In this case, there is additional value from this analysis because the news weighed heavily on other tech stocks.
As a starting point, let us see the details about the guidance miss that were given in the earnings call. First, the miss was attributed to disappointing revenues from new software licenses, as some sales that were to be closed in late November were postponed by customers who justified the delays on additional approval requirements. An interpretation of this unexpected caution is that these customers re-evaluated the cost-benefit of these capital expenditures in light of the shaky financial scene, possibly with some participation of credit contraction. President and CFO Safra Catz was clear that these were delays rather than cancellations, as customers did not say that their budgets had changed but rather postponed purchases, in some cases by a few days but enough to affect quarterly results.
The other reason given for the miss was currency fluctuation. The U.S. dollar strengthened during the quarter, impacting on foreign sales when these are expressed in dollars. About half of Oracle’s revenue is acquired outside of the U.S.
The company also reported a contraction of hardware sales, but I would not read much into this. Since receiving these operations when it acquired Sun Microsystems in early 2010, Oracle is renouncing to the commoditized low-end server business in favor of the higher end, which provides better margins. To add to the effect on revenue of that transition, the company recently introduced a new generation of servers. Delivery of this new line started right before the end of the quarter, with just a few units delivered in late November according to Catz, so it can be presumed that customers postponed purchases to buy from the new generation, which was almost not available before the end of the period. The novel product line is exhibiting remarkable performance and profit margins are improving, I do not take last quarter’s decrease in revenue as a sign of weakness in Oracle’s hardware front.
Given the disappointing sales of new software licenses and the guidance reduction, the price correction looks fairly reasonable to me. Actually, I wonder if the amount of the drop is a bit too much, as the forecast may have been prepared with extra caution to avoid missing for a second quarter in a row, since it’s difficult to predict capital expenditures during these months, particularly for Europe. But Oracle, being a widely-followed stock, experiences reasonable price movements more often than not. Irrational price changes akin to companies that have small market capitalizations are not frequent with these giants.
Moreover, it also appears reasonable that this news impacted on other tech stocks, as there is a chance that Oracle’s peers are experiencing similar timid demand and currency volatility.
On the other hand, I do not see a reason to sell. The announcement was discouraging, but it was presumably priced into the stock on Wednesday. Oracle leads its business and is doing many things well. Its product pipelines are growing, its balance sheet is healthy, it is building synergies between its traditional software business and the newer hardware operations, as it is able to sell integrated hard-soft solutions now. Margins are improving and the new generation of hardware shows promise. Furthermore, the company may take steps into the hot business of cloud-computing services. The stock is valued significantly lower than its highs in May, indicating that the possibility of recession may be considered in the stock price already. On the other hand, the risk factors remain unmodified, so I do not think the role of my stocks in the model has changed.
After such a drop I would normally consider rebalancing by adding some shares to move the allocation back to its previous proportions, but many stocks in the Emerging Market Sector Focus model have higher beta and, as such, have been severely hit by the turmoil that followed the inception of the model in July. Despite those movements, I did not trade much because I am maintaining a cautious stance until there is more actionable news coming from Europe. I would not like to sell one of the punished high-beta stocks to add to Oracle and neither would I increase margin.
The earnings announcement was important, as all are. In this instance it was discouraging, although there were some positive points. Yet I try not to lose perspective when there is a sudden price change like this. The performance of the stock will be defined mostly by the accumulation of everyday small movements that do not draw so much attention as these flashy but infrequent corrections.
