We are upgrading software giant Oracle Corp. (ORCL) to Outperform from our previous Neutral rating based on our incrementally positive outlook on the stock.

Oracle’s better-than-expected second quarter 2011 results with both earnings and revenues beating estimates and robust third quarter 2011 outlook have led to a substantial rise in earnings estimates for the third quarter and full years 2011 and 2012.

Oracle is expected to gain from strong software license revenue growth, focus on improving profitability, increased product momentum, improved margin, high recurring revenues and growth in hardware sales.

Oracle is a leader in database software business and continues to gain share in the database as well as applications software market.

Second Quarter Earnings Highlight

Total revenue, growth in new licensing revenues and earnings per share (EPS) were encouraging and remained well above management’s expectations. They also show that the demand for software is pacing up.

Earnings (excluding one-time items but including stock-based compensation expenses) of 49 cents per share shot up 32.4% from 37 cents in the year-ago period, and surpassed the Zacks Consensus Estimate of 44 cents. The rise in earnings was attributable to increased revenues from new software license sales, which grew for the fifth consecutive quarter.

Second quarter total revenue increased 47.0% year over year to $8.58 billion, driven by better-than-expected new software license revenues. Non-GAAP revenues leaped 47.3% year over year to $8.65 billion. Revenues were also above the Zacks Consensus Estimate of $8.30 billion.

New software license revenues (23.1% of total revenue and 35.3% of total software revenue), shot up 20.9% to $2.00 billion and exceeded the company’s expectation. Revenues from hardware systems products were $1.11 billion, in line with the company’s expectation.

Robust Third Quarter Outlook

Management provided robust third quarter guidance. Total revenue growth on a non-GAAP basis is expected to range from 31% to 35% at current exchange rate and 30% to 34% in constant currency. New software license revenue growth is expected to range from 10% to 20% at current exchange rate and 9% to 19% in constant currency.

For the third quarter, Oracle expects non-GAAP EPS in constant currency to range between 48 cents and 50 cents. Assuming the current exchange, EPS is expected to range between 48 cents and 50 cents. This is up from 38 cents reported in the comparable quarter last year.

Estimates for the third quarter 2011, fiscal 2011 and fiscal 2012 are up by 6.8% ($0.03 per share), 5.3% ($0.10 per share) and 5.2% ($0.11 per share), respectively. Oracle’s results indicate increased business spending by corporations.

Oracle’s acquisition of Sun Microsystems will provide an impetus for growth in fiscal 2011 and beyond with higher top and bottom-line growth along with increased accretive synergies strengthening its competitive position.

However, integration issues, intense competition and slow growth in IT spending are areas of concern.

We believe that winning $1.3 billion at a trial against SAP AG (SAP), a leading provider of enterprise resource planning (ERP) software will give Oracle a shot in the arm as the latter is its primary competitor.

The company’s attractive balance sheet and cash floware remarkable. Oracle currently has $24.8 billion of cash and short-term investments on the balance sheet ($4.86 per share) and $8.68 billion in free cash flow or 128% of net income in the trailing four quarters.

We also remain positive on Oracle’s growing Exadata pipeline, despite intense competition from International Business Machines Corp. (IBM) and EMC Corp. (EMC). Management expects the Exadata pipeline to grow to $2 billion.

We are positive on Oracle’s longer-term growth prospects, given its growing market share, focus on improving profitability, new product pipeline, cost saving initiatives and robust free cash flow.

With an increase in estimates, Oracle is currently rated as a Zacks #1 Rank (short-term Strong Buy) stock.

 
EMC CORP -MASS (EMC): Free Stock Analysis Report
 
INTL BUS MACH (IBM): Free Stock Analysis Report
 
ORACLE CORP (ORCL): Free Stock Analysis Report
 
SAP AG ADR (SAP): Free Stock Analysis Report
 
Zacks Investment Research