Oracle Financial Services Software: Why it is time to book profits after 260% returns from our buy recommendation

While much of the IT stocks and the Nifty IT index have struggled to breach all-time highs they had reached a couple of years back, one stock — Oracle Financial Services Software (OFSS) — has been a remarkable exception. The stock has been setting new records and new all-time highs during the course of the year.

OFSS is one stock that bl.portfolio had maintained a positive stance on, amid our overall cautious stance in the Indian IT space over the last 2-3 years. This stance has largely played out now, with OFSS outperforming the sector significantly. The stock is up 150 per cent in the last one year as compared to Nifty IT up 22 per cent. Since our buy recommendation on OFSS (‘Play the waiting game’ in bl.portfolio edition dated October 2, 2022), OFSS has given total returns including dividends of 260 per cent (vs Nifty IT’s total returns of 35 per cent).

Is it time to take stock? We believe it is. Through this period of significant outperformance, the valuation of OFSS has expanded from an ultra-attractive one-year forward PE of 11.5 times to quite an expensive one-year forward PE of 33.5 times (more than double the five-year average of 16 times). In October 2021, OFSS represented the quintessential example of a deep value stock. With some rerating playing out in the early part of the year when its PE moved up to 23 times, we had recommended that investors continue to hold the stock, in our update published in bl.portfolio edition dated February 4, 2024 (‘Sufficient positives to bank on for now’). However, now the valuation appears stretched with, in our view, not much room further for any rerating. We recommend that investors book profits in the stock and lock in on the gains.

Post uptick in its business reported in January 2024 at the time of its Q3 earnings release, which triggered the rerating in the stock, the growth prospects are now reflected in forward estimates. Expectations now are for FY24-26 revenue/EBITDA/EPS to growth at a CAGR of 11, 13 and 12 per cent respectively. One-year forward PE at 33.5 times more than adequately factors this. In our view, the risks are more to the downside than upside from here, making it unfavorable to hold the stock anymore.  Many IT stocks peaking out between mid 2021 and an early 2022 after reaching high valuation relative to growth prospects is a clear indication that valuation matters. OFSS is unlikely to be an exception.

Business

OFSS is a global leader in providing IT solutions to the financial services industry. It offers comprehensive banking applications across the spectrum of retail, corporate and investment banking to financial institutions. Its technology solutions include core banking technology and cover end-to-end requirements (front to back office) in the financial services industry and also include risk management, analytics and forensic finance.

It is a software products company and earns revenue by way of licensing, consulting and maintenance fees linked to the product. Its flagship product is Oracle Flexcube. The company also earns some revenue from allied services and BPO. However, these currently form a small part, with products revenue accounting for 90 per cent of total revenue. Within its products business, the company has been adapting well to the changing dynamics in the industry with the shift towards SaaS (software as a service). It has been making investments in this space and a large portion of its banking product portfolio is now available as a cloud service.

OFSS is geographically well-diversified with around 25 per cent of revenues from the US, 15 per cent from Europe, 25 per cent from APAC, 16-17 per cent from West Asia and Africa, around 11 per cent from India and balance from rest of the world. Typically in the Indian IT space, the US and Europe account for 80-90 per cent of revenues for many companies. OFSS’ much lower exposure to these geographies and healthy diversified geographic mix enabled it to buck the trend versus other IT players in FY24, wherein it reported better revenue and earnings.

Recent performance

FY24 revenue increased 12 per cent to ₹6,372 crore and net income increased 23 per cent to ₹2,219 crore. The stronger growth in net income relative to revenue is unlikely to repeat, going forward, as it benefited from a margin rebound, post decline in FY23, as a result of which earnings had declined by 4 per cent in FY23.

Further, post a solid 3Q, when revenue and licence wins increased 26 and 80 per cent Y-o-Y respectively, Q4 saw some reversion, with revenue growing 12 per cent and licence wins declining 31 per cent.    

Quarterly volatility apart, the company is likely to continue stable/steady performance over the next few years. This is fully factored at current levels. Our thesis on the stock has fully played out and hence investors can book profits.