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Oracle Corp (ORCL) will release its fiscal Q1 2025 results on Sept 9. It's expected to show strong free cash flow (FCF) results, including high FCF margins. That could power ORCL stock higher and it could be 15.5% undervalued. This puts its price target at over $161 per share.
Oracle is moving quickly into the AI arena - essentially selling the shovels (i.e., cloud storage and data centers) to the miners (AI users and developers of large language models). Moreover, it's also selling its own AI software platforms, especially in the healthcare arena.
As a result, the company is expected to show strong and consistent free cash flow (FCF), despite higher capex spending. I discussed this in a previous GuruFocus article on April 23, “Oracle is Too Cheap.”
One way to play this is to sell short out-of-the-money (OTM) put options in nearby expiry periods. Given the stock's low dividend yield (1.1%), this play could give investors extra income. Moreover, if ORCL stock falls after the earnings release, shorting OTM puts allows investors to buy in at a lower price.
Strong FCF Results
During the past fiscal year ending May 31, Oracle reported that its free cash flow was up 39% YoY at $11.8 billion. As seen in the table below, this was down slightly from the prior quarter's trailing 4 quarters (T4Q) FCF of $12.358 billion.
However, most of the decrease came from higher capex spending. Nevertheless, its recent full year of $11.8 billion in FCF represented 22.3% of its $52.96 billion in revenue.
Analysts are projecting significantly higher revenue over the next 2 fiscal years. For example, Seeking Alpha's survey of 29 analysts shows an average of $57.92 billion in revenue this fiscal year to May 2025 (i.e., +9.365% over $53 billion this past year). Moreover, next year they forecast $64.26 billion in sales, for an average run rate of just over $61 billion ($61.09 b) over the next 12 months.
Therefore, applying a 22.3% FCF margin against this revenue forecast results in $13.62 billion in forecast free cash flow. That implies the company's FCF could rise over 15.35% from the trailing $11.8 billion shown above.
Assuming the company reports strong FCF margins next week, this could underline strong free cash flow expectations for Oracle going forward.
Price Target for ORCL Stock
As a result, ORCL stock could be worth at least 15% more. For example, if we use a 3.0% FCF yield metric the value of ORCL stock could rise to $454 billion (i.e., $13.62 billion FCF forecast / 0.03 = $454b).
That is 15.5% over today's market cap of $393 billion. In other words, ORCL stock could be worth 15.5% more than its price today of $139.65, or $161.29 per share.
Why use a 3.0% FCF yield metric? This is what the market seems to have settled on with ORCL stock. For example, in the last 12 months ending May 31, the company generated $11.8 billion in FCF. So, if we divide $11.8 by its market cap of $393 billion, that works out to a 3.0% figure.
The bottom line is that Oracle's strong FCF could drive ORCL stock at least 15% higher over the next year.
Shorting OTM Puts
One way to play this and generate extra income for existing shareholders is to sell short out-of-the-money (OTM) put options in nearby expiry periods. For example, the $130 strike price, which is almost $10 below today's price (i.e., 7.5% out-of-the-money) for the Sept. 27 expiration period trade for $2.55 on the bid side.
This is a very high yield of almost 2.0% (i.e., $2.55/$130 = 1.96%) for just three weeks until expiration.
Here is what that means. The investor who shorts this put first secures $13,000 in cash and/or margin, to buy 100 shares at $130, with their brokerage firm. Then, after gaining approval to do this trade, they enter an order to “Sell to Open” 1 put contract at $130 for expiry on Sept. 27.
The account will then immediately receive $255. That works out to almost 2.0% of the $13K invested. Now, unless ORCL stock falls to $130 on or before the Sept. 27 expiration, the investor has no obligation to buy 100 shares with the $13K invested.
So, you can see that this works out well for existing investors, assuming they can repeat the trade every 3 weeks. For example, over the next quarter, they stand to make over $1,000 (i.e., $255 x 4 = $1,020) if the same trade can be repeated each time. That results in an expected return (ER) of 7.85% of the $13K invested over that period.
In other words, existing investors in ORCL stock can enhance their performance, and provide extra income in case the stock falls. The bottom line is that ORCL stock looks cheap here and one way to play this is to short OTM puts.
If Oracle's earnings and FCF margins hold up next week, as expected, this could be a very profitable trade.
On the date of publication, Mark R. Hake, CFA 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. For more information please view the Barchart Disclosure Policy here.
