Oracle’s "weak" results amplifies the outlook for AI accelerators

Key Points

• Oracle had a weaker-than-expected quarter, but the top-line miss is slim, and margins are impressive.
• A shortfall in capacity is a leading cause for weakness; capacity is ramping now and over the next several quarters, so price weakness is a likely buy-the-dip opportunity. 
• Demand for capacity equals demand for accelerators, a demand that NVIDIA can't fill by itself: there is a void for Advanced Micro Devices to fill. 

Oracle NYSE: ORCL had a weaker-than-expected FQ2 relative to analysts' expectations, but the outlook is as robust as ever. The biggest takeaway from the report is that weakness was caused by insufficient capacity, and capacity is ramping. The news for investors is that Oracle will continue to grow, cloud and AI will continue to overtake its legacy business, and the market for AI accelerators is ramping up. 

“There's this gold rush towards building the world's greatest large language model. And we are doing our best to give our customers what we can this quarter, and then dramatically increase our ability to give them more and more capacity each succeeding quarter,” said chairman and co-founder Larry Ellison during the conference call. 

Among the causes of insufficient capacity is a shortfall of NVDA NASDAQ: NVDA and other capable accelerators. NVIDIA is ramping up production as quickly as it can, but there is a void to be filled. Advance Micro Devices NASDAQ: AMD is the leading player to fill the void, which launched its AI-specific accelerators, and Oracle is a known partner. 

This means that NVIDIA can be expected to have another mind-blowing year in 2024, and Advanced Micro Devices will also have an NVIDIA-like year. AMD’s new line of MI-300 accelerators provides a choice for the leading cloud operators and enhances performance for clients in many use cases, so it will likely significantly exceed CEO Lisa Su's $2 billion revenue target. 

Oracle has a solid quarter; shares implode

Oracle had a solid quarter with revenue of $12.94 billion, growing 5.4% YOY. This is weaker than expected but by a slim 80 basis points and offset by strength in critical segments, a healthy outlook for growth and a widening margin. The Cloud segments led with growth of 25%, offset by weaker sales in legacy businesses. Within the cloud segment, services grew by 15%, while infrastructure grew by more than 50%. 

Margin news is impressive for this tech stock. Strong gross and operating margins offset the company’s slim top-line weakness; the operating margin is up 200 bps YOY on scale and leverage, leaving adjusted earnings above the consensus. Adjusted earnings came in at $1.34 or a penny hot, giving a taste of what’s to come over the next few quarters as Oracle builds its data center empire. The company has plans to build dozens more data centers over the coming years, including private clouds for governments and large enterprises. 

Oracle’s guidance is a factor weighing on the share price. The guidance is favorable, expecting growth near 7% and wider margins, but aligns with Marketbeat.com’s analyst consensus estimate, providing no catalyst to rally. However, the guidance remains solid; the company is on track to grow consistently over the next few years, so the price pullback is a likely buy-the-dip opportunity for investors. 

Analysts trim targets: it’s wait-and-see time for Oracle

Analysts remain bullish on Oracle but began trimming price targets following the Q2 release. The first two showing up on Marketbeat’s radar are from UBS Group and BMO Capital Markets, which lowered their targets to $125 and $126, respectively. The bad news is that more downward revisions may come; the good news is that these targets are above consensus, and the consensus figure has been relatively steady for the last few months, implying about a 20% upside with the post-release plunge in share prices. 

Shares of Oracle fell about 10% following the release and are trading near the bottom of a major consolidation range. This range has been in play since the AI boom drove the stock to new highs early in 2023. Because the outlook is still robust, Oracle shares will unlikely fall below the range; instead, they will likely continue to consolidate within it as analysts and investors wait and see what comes next. Assuming the company continues its plans, the following quarters should produce significant growth, widening margin and ample cash flow for repurchases and dividends.