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SUMMARY
Parkev Tatevosian, CFA, analyzes Oracle's financial outlook amid significant investments in AI infrastructure, using a discounted cash flow model to assess the stock's intrinsic value. Despite projected future free cash flow growth, the analysis concludes that Oracle is currently fairly valued rather than undervalued.
MAIN POINTS
- Oracle is making large investments in data centers to support AI contracts, resulting in negative free cash flow.
- Free cash flow is projected to remain negative until 2029, when it is expected to turn positive and grow substantially.
- Oracle's revenue growth is tied to contracts, particularly with OpenAI, but there are concerns about the reliability of these obligations.
- The discounted cash flow model uses a weighted average cost of capital of 11.72% and values Oracle's operations at $666 billion.
- After accounting for non-operating assets and debt, Oracle's equity value is calculated at $561 billion, leading to an intrinsic value of $195 per share.
- With the market price at $192, the stock is deemed fairly valued, not significantly undervalued, due to the narrow margin and inherent model uncertainties.
DETAILED ANALYSIS
Oracle is currently undertaking substantial capital expenditures to build out data center infrastructure aimed at supporting its artificial intelligence service contracts. These investments have resulted in negative free cash flow, a trend projected to persist through 2028. According to the discounted cash flow model presented, Oracle is expected to report a negative free cash flow of $24 billion in 2026, worsening to $29 billion in 2027, and remaining negative at $19 billion in 2028.
The turning point is anticipated in 2029, when free cash flow is forecasted to become positive at $34 billion, with further growth to $96 billion by 2035 as capital expenditures decrease and revenues from new data centers materialize.
A significant portion of Oracle's future revenue is linked to contracts with organizations such as OpenAI, contributing to a backlog valued in the hundreds of billions. However, there is investor skepticism regarding the reliability of these contracts, particularly Oracle's exposure to OpenAI's ability to fulfill its obligations. The valuation model applies a weighted average cost of capital of 11.72%, incorporating a cost of debt of 7%, a cost of equity of 13.74%, a beta of 1.54, and a market risk premium of 6%, with a target capital structure of 30% debt and 70% equity.
Discounting projected cash flows results in a present value of operations of $666 billion. After adjusting for non-operating assets and subtracting debt, the equity value is calculated at $561 billion. When divided by the number of shares outstanding, this yields an intrinsic value of $195 per share.
With Oracle's market price at $192, the difference is less than 1.5%, which falls within the analyst's margin of safety of 10%. Given the proximity of the market price to the calculated intrinsic value and the uncertainties inherent in financial modeling, the stock is considered fairly valued rather than undervalued at current levels.
LINKS
- YouTube channel membership for exclusive perks and spreadsheets.
- The Motley Fool special offer for stock recommendations.
- Parkev Tatevosian's book on stock evaluation.
- Fiscal.ai investment research platform with a discount for viewers.
- Webull investing platform sign-up with bonus shares.
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