Oracle’s (ORCL) Q1 earnings report last month impressed everyone. The company’s $300 OpenAI deal and contracts with major companies are driving a new wave of growth, one that has even impressed Jensen Huang. The Nvidia (NVDA) boss referred to the company as “wonderfully profitable,” a strange remark considering the very business he is doing with Oracle is an extremely low-margin one. The Oracle Cloud Infrastructure (OCI) service is facing criticism because of the extremely low (14%) gross margins of the service that runs on Nvidia-supplied GPUs. This has also brought down the company’s overall gross margins to 69.66%, compared to the 5-year average of 75.45%. Should that worry investors?
Oracle sits on the cusp of an incredible AI opportunity. Even the management called it an “approaching tsunami” on the recent earnings call, saying not everyone is grasping the extent of the opportunity. Oracle is slowly transitioning to a major AI infrastructure company from a database company. The Q1 earnings were just a glimpse of what’s to come, and Jensen’s positive comments only add to what the management and Wall Street are already claiming.
Oracle is a company that provides products and services that help businesses run their IT environments. The company currently has a market cap of around $850 billion and is based in Austin, Texas. It is up an impressive 81% this year so far, comfortably outpacing the S&P 500’s ($SPX) 12.66% gains, thanks to its critical role in providing AI infrastructure.
As is the case with many AI stocks, they look overvalued at first. Oracle’s forward price-to-earnings (P/E) ratio is 60.26x compared to the IT sector’s median of 32.8x. The firm’s 5-year average P/E is just below the median, so the stock is trading at a premium to both the sector and its own recent history. The question is whether the premium already prices in the great opportunity that Oracle sits on?
This can’t simply be explained with financial ratios. ORCL stock has been rallying for some time now, and this has also reduced its dividend yield to half of its 5-year average, which was 1.33%. The ratios being above average is therefore a given. The stock is arguably undervalued, considering the AI prospects being talked about, and some of the evidence for this lies in the recent earnings report.
Last month, the company announced its fiscal Q1 results, posting an adjusted EPS of $1.47 versus Wall Street estimates of $1.48. The revenue also came in short at $14.93 billion against the consensus estimate of $15.04. ORCL stock still soared 30%, though, and a lot of it had to do with the outlook. The company expects a mid-teens growth rate in FY26, with cloud revenue expected to grow at 25% at the midpoint. It expects to add further multibillion-dollar contracts going forward, exceeding the 500 billion Remaining Performance Obligations (RPO) mark.
The RPO figure is interesting because it contains both the upside and the risk of investing in Oracle. The firm has an RPO worth $450 billion currently. It has a quarterly revenue of just over $14 billion. The RPOs are worth 32 times that revenue. Obviously, these future revenues are not guaranteed. They also come with a big disclaimer: $300 billion of these are expected to come from OpenAI alone, a fact that was released just a day after the Q1 earnings. This is a huge commitment on the part of the ChatGPT creator and a concentration risk for Oracle. However, only time will tell how this turns out. Despite all the optimism and upside of Oracle AI ventures, investors still need to be aware of the risks.
The consensus analyst rating for Oracle is “Moderate Buy,” based on 40 analyst ratings. Twenty-eight of these analysts have a “Strong Buy” rating on ORCL stock, which shows how bullish the market currently is on the company’s prospects. Only three more “Strong Buy” ratings have been assigned since the $300 OpenAI deal, which shows that a vast majority of the analysts were already bullish on the stock even before that mega deal happened.
The mean target price, according to analysts, is $340.34, which still offers upside of 12%. Despite all the AI hype around ORCL stock, the fact that it is still trading below the mean target price shows it hasn’t run ahead of its fundamentals and is still an attractive buy.
On the date of publication, Jabran Kundi did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. This article was originally published on Barchart.com