Sterne Agee analyst Robert Breza initiates coverage of Oracle Corporation (NYSE:ORCL) with a Neutral rating and $40 PT. full report below:

Oracle

Initiating coverage with a Neutral rating and $40.00 price target. Resumption of growth will re-invigorate investors’ appetites. Database remains strong and Hardware has begun to stabilize, while Applications growth has not materialized when excluding acquisitions. In our opinion, margin expansion should be utilized to drive growth, increasing overall EPS.

Growth vs. margins

Investors are waiting for New Software Application license growth which grew 2% YoY in the most recent quarter. Oracle Corporation (NYSE:ORCL) is expected to grow revenues 3.7% in FY14 after a relatively flat year in FY13 creating easy comparables; however, growth only accelerates modestly to 4.8% in FY15. This lack of growth has caused many investors to question the overall strategy. Oracle enjoys some of the highest operating margins in the software industry which were over 47% and are expected to improve YoY for FY14 and FY15. We believe most investors would rather see flat margins with the investments used to accelerate a higher growth rate leading to more EPS.

Oracle diversification and discontentment

Oracle Corporation (NYSE:ORCL)’s cloud acquisitions were expected to drive additional demand for Fusion applications; however, Applications growth remains a concern for investors. Oracle continues to hold onto its number one market position in database, despite the rhetoric regarding SAP’s Hana. Oracle Corporation (NYSE:ORCL)’s diversification into hardware, which has been a pain point for investors, has shown signs of stabilization from a revenue growth perspective, indicating that the worst could be behind the company.

Improving recent results

Q2 Revenue/EPS results of $9.3B/$0.69 topped consensus of $91.8/$0.67 with Revenue/EPS growth of 2%/23%, respectively, driven by better than expected results in hardware and software updates. Q3 Revenue/EPS guidance at the midpoint was essentially in line at $9.33B/$0.70 vs. consensus of $9.35B/$0.70.

Valuation is equal risk/reward

Currently, Oracle Corporation (NYSE:ORCL) trades at a P/E ratio of 12.2x our FY2014 EPS estimate which is a slight discount to the legacy software group mean multiple of 13.4 (excludes Adobe). Our $40 PT target assumes Oracle Corporation (NYSE:ORCL) trades at 13.5x on our FY/14 EPS of $2.96 estimate and represents an in-line multiple with the legacy software group. In our opinion an in-line multiple is justified given the stability of growth and size of the Database business as well as other potential areas for improving growth.