Oracle and the AI Boom

In this podcast, Motley Fool analyst Tim Beyers and host Ricky Mulvey break down results from Oracle and why Microsoft is focusing on start-ups for the next leg of its AI strategy.

Plus, Motley Fool analyst Anthony Schiavone and host Mary Long look at Hershey‘s near-term headwinds and the long-term opportunity for investors.

To catch full episodes of all The Motley Fool’s free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on June 13 2024.

Ricky Mulvey: It’s the Cloud behind the Cloud. You’re listening to Motley Fool Money. I’m Ricky Mulvey, joined today by Tim Beyers. Tim, we were talking earlier, and I have to say, you sound a lot less caffeinated when I’m talking to you on Zoom versus when I’m listening to you at 1.5 speed on Motley Fool Live, but I appreciate you being here. Thanks for being here.

Tim Beyers: Thanks, Ricky. Good to be here. I still have caffeine. I’m ready to go.

Ricky Mulvey: Okay.

Tim Beyers: Let’s go.

Ricky Mulvey: Let’s go. Let’s start with Oracle, because the software giant reported earlier this week. Investors liked the results. Stock’s up about 13% on it. That’s pretty good for something like a 300 billion-dollar company. I’m going to give some of the highlights and then see what stood out to you. There seems to be a lot of new business coming Oracle’s way with the remaining performance obligation, which is how much money is left in those contracts, up 44% to almost 100 billion. They got 30 new AI contracts for over 12 billion signed just this quarter. We also have Larry Ellison touting deals with NVIDIA, Microsoft, Google, xAI, who are all using Oracle Cloud services and data centers. Anything from this quarter from Oracle really stand out to you?

Tim Beyers: Well, it’s a good quarter overall. Let’s give credit where credit is due here. The Cloud services and license business was up 12% on a pure basis, 11% in terms of constant currency, overall revenue up 6%. This is a big company, so 6% for a big company that generates essentially 53 billion dollars in a given year. Six percent is quite a lot, but it is notable that Oracle really depends on that Cloud business, that AI business doing what it’s doing presently. There is something great about the way that Oracle has structured this. The idea here, Ricky, you said the Cloud behind the Cloud, and I think that’s a fairly good description here, because what’s happening is that Oracle is selling some hardware, and it sells its Cloud services. It interconnects them into the other Clouds. When you are, say, working inside of, for example, Microsoft Azure, you may be touching some Oracle equipment, you might be touching some Oracle services, you might be touching the Oracle databases because there is Oracle stuff. I’m not trying to make anybody hungry here, Ricky, but if you could think of it as the OREO cookie, Microsoft, they’ve got the chocolate wafers, and then you’ve got some stuffing inside that is made of some mystery stuff, and inside the mystery stuff is some Oracle stuff. How’s that?

Ricky Mulvey: I’m still a little lost on the OREO’s to Cloud data services provider, but one way I’ve heard this explained, and it makes sense, is Oracle has something called remote direct memory access. What this allows computers to do is essentially get the data from one computer of another without essentially involving the operating systems of either. If you’re using a huge database that you need for an AI system, it would make a lot of sense to use an Oracle Cloud solution.

Tim Beyers: But all of that is dependent, of course, on it being set up inside the environment, such that you could access it through that remote data scheme. Now, to be fair, I’m not entirely familiar with exactly how Oracle sets this up. What I do know is that, by virtue of these interconnect agreements, and by virtue of essentially Microsoft, Google, and others reselling Oracle by virtue of putting Oracle inside their environments, that’s a great position for Oracle to be in because it means that as these Clouds expand capacity for doing things like serving AI workloads. That’s just more good business for Oracle. It’s another great channel for them, so they do have something to crow about here. It’s different than them just selling their Cloud independently and trying to compete with the others. It’s a bit of Judo, and frankly, it’s a bit of smart Judo. I give them credit for that. At the same time, this is a company that’s not growing very quickly but is issuing a whole boatload of equity. They are issuing equity, Ricky, as if they are a growth company, and they are verifiably not. I find that fascinating that nobody talks about that.

Ricky Mulvey: Just for the listener to be aware, this is a take that Tim has been itching to give, which is the stock-based compensation coming out of Oracle. Oracle spent about four billion on stock-based comp for the year. The company made 53 billion in revenue in a little under 19 billion in cash from operations. We’ll focus on that four billion in stock-based comp and about 19 billion in cash from operations. Let’s set up the landscape first. How does this stack up to the competitors? Why is this drawing your attention now, Tim?

Tim Beyers: Well, it’s very similar to Salesforce. I suppose I shouldn’t really be bothered by that, Ricky, but I think it’s interesting that the way that Oracle issues equity, and at the rate that they issue it, is like a growth company, is a little bit like Salesforce, except that it’s going higher. They’re issuing more of it, and Salesforce is issuing less. Now, on the basis of a ratio, let’s say as a percentage of revenue, like 7.5% of Oracle’s revenue issued as equity, stock-based compensation, Salesforce, it’s about 8%. Salesforce is still higher, but I think we tend to think of Oracle as a mature, established, settled company that’s in the Microsoft realm. Not by virtue of its stock-based compensation; it isn’t. It’s still issuing a huge amount of equity. What that tells me, Ricky, is that the cost of Oracle, the cost to essentially grow its opportunity, is really high. They have to pay some serious premiums to people in order to get them in the door and do the work that creates this position, and to be fair, it’s a fairly enviable position, but I just find it startling that the costs are that high. One of the things that makes them different is they have about seven billion dollars in just really hard-core capital expenditures. They are building equipment, they are building data centers, they’re investing in a lot of hard goods, and that makes them different from a company like Salesforce. But it’s a company that’s far older than a peer like Salesforce, because they’re born in the 1970s. I would put it this way. It’s like the older gentleman having a midlife crisis and is spending like that midlife crisis is in full swing. That is fascinating to me because we’re not behaving like Oracle is that company, but they are, Ricky, they are.

Ricky Mulvey: If you look at the stock chart for Oracle and the chart for stock-based compensation, they seem to be moving in tandem, which is almost on a logarithmic curve up into the right. As long as the performances are matching each other, doesn’t that make it more forgivable?

Tim Beyers: Certainly.

Ricky Mulvey: Oracle didn’t just start issuing stock-based compensation. This is not an ending story for the company.

Tim Beyers: They’ve been doing this for a while. Yes, there is an end, justifies the means argument here, which sounds terrible that I just tried to diminish your argument there. I’m not trying to do that.

Ricky Mulvey: Diminish.

Tim Beyers: No, I’m not trying to do that because I think you are correct. If you are earning above, if the boat anchor of that equity is overcome by stock returns for common shareholders, by all means, do what you got to do. That is the argument for Salesforce for all those years, that they were doing it at an elevated level as well. Yes, there is that argument, but I just find it interesting. We should know what Oracle is. It is a company that’s going to keep having to pay out a lot of equity to employees to make this dream of being the Cloud behind the Cloud real for the foreseeable future. I think they’re in a pretty good position because their hardware is quite good. Their Exadata hardware is quite good. I think they do a lot of work in terms of hardware-accelerated databases, and their database technology is good. They also have a lot of database product that you’re not going to find a database engineer that is going to tell you that Oracle is terrible. They’re going to say it is the standard, and they are correct. Having said that, though, the growth rates are not massive. They have to pay a lot of money to get those growth rates, and they are in the business of trying to turn over dollars wherever they can find them. For example, they are going to go back to going after, Ricky. They’re going to go after companies that use Java because Oracle owns the Java license, and so you could think of that as the enterprise tech equivalent of, hey, you are sharing your parents Netflix password. You need to pay us. It’s a little bit like that. Oracle’s really good at extracting money. When your business is built in part on generating some value but an arguably bigger part or just as big part on extracting money from customers, it makes it dicey. I am fairly biased here, and I will admit that because I have witnessed the Oracle extraction machine firsthand for years and I have the scars. I’m probably a little biased there, Ricky.

Ricky Mulvey: Well, I appreciate the vulnerability, sharing the scars of Oracle [laughs] with the show. I want to stay on the Cloud, but move to this Microsoft story. There’s an article in the Wall Street Journal. It’s titled: Microsoft’s Nadella is Building an AI Empire. OpenAI was just the first step. It’s by Tom Downey and Berber Jin. I would recommend reading it. It’s a good story. But there’s a line in here that stands out to me because it’s a part of Microsoft’s AI ambitions that we haven’t talked a lot about, and it is this, “One of Nadella’s top priorities today is rebranding the Azure Cloud is the go-to place for start-ups”. Why is this such a priority, you think at Microsoft? What are they responding to?

Tim Beyers: I think they are responding to VCs who are writing really big checks, saying, look, we want you to go for it; we want you to adopt AI into your business. We want you to be building AI-enabled applications. For the love of God, don’t you dare go buy NVIDIA GPUs. Go rent from Microsoft, go rent from AWS, go rent from GCP. This is eerily reminiscent, Ricky, I would say, of 2010, when VCs were saying, the Cloud is amazing. We want you to build SAS applications. Go do it. For the love of God, you better not use a dime of our money to buy servers and storage equipment. Go take a credit card, swipe it, and get AWS, and start building now. We don’t want you spending a dime on infrastructure. It feels like that. And for that opportunity, that’s great for Microsoft because they have all of the NVIDIA GPUs. They could say, StartupX, come to us, pay us a little bit of money, we will give you access via your Azure environment to NVIDIA GPUs, your virtualized NVIDIA GPUs, to run your AI-backed applications. They are the supplier of the AI horsepower through that Azure environment, and so the start-ups don’t have to carry the burden of trying to source NVIDIA GPUs, which, as we all know right now, we’ve seen the numbers, ermagerd profits for NVIDIA. They are amazing. It’s just hard to get NVIDIA GPUs. I think there’s a real race to be the supplier of access to GPU compute power, and Microsoft wants to be the winner here.

Ricky Mulvey: Do you think that could dampen the demand for those NVIDIA GPUs if there becomes more of a, you can rent it from Microsoft? You don’t have to go out and buy these things.

Tim Beyers: Not in the short term. There’s still so much demand, there’s still so much backlog, plus I still think NVIDIA has the software advantage. You still need that low-level software called Kuta in order to make GPUs do their GPU tricks. As long as that’s true and NVIDIA is the preferred provider here, there is an alternative ecosystem where you’ve got AMD ROCm or some open source version of Kuta that does most things that Kuta does. There’s still going to be a huge amount of demand for NVIDIA, but over time, give it 18 months, 36 months, I think there will be a buildout of alternatives such that you’re going to find companies that say, wait, I don’t have to pay an NVIDIA tax. Yes, give me that. I will try it.

Ricky Mulvey: Then there’s another company that I think could be impacted by this, and that’s DigitalOcean. A lot of the promise of DigitalOcean’s Cloud services is, we’re going to find small customers, and then you’re not going to pay that much, but you can grow in scale with DigitalOcean, and then we’ll make more money when you’re a larger company, and you need more Cloud services because we’re so much better at treating smaller customers than these large companies like Microsoft. Now it seems that Microsoft is saying, no, we’re going to spend a lot of attention on those small customers. What does this initiative mean for DigitalOcean?

Tim Beyers: I think it means that it’s going to be a lot harder to win smaller AI workloads, which I think DigitalOcean was really hoping they were going to get their hands on. They may still. DigitalOcean still is the gold standard for documentation to help developers do their work better. AWS has everything, but helping you get the right tool for the right job, is not their strength, and I’m being polite there deliberately, and I’m not sure that it’s Microsoft’s strength, either, and I’m not sure it’s Google strength. What they want is volume of workloads. Are they going to be as high-touch as, say, DigitalOcean? Probably not. But is this going to take some business that DigitalOcean was maybe banking on? I wouldn’t be surprised if it happened, Ricky. The next quarter that we see for DigitalOcean is going to be interesting. I’d be paying particular attention to the outlook when they report next.

Ricky Mulvey: Today’s show is sponsored by public.com. That’s where you can earn a 5.1% APY with a high-yield cash account. While we can’t say for certain it’s the highest interest rate there is, we can say this: It’s a higher rate than SoFi, a higher rate than Marcus, a higher rate than Wealthfront, a higher rate than Betterment, frankly, a higher rate than Capital One, a higher rate than Ally, a higher rate than Barclays, a way higher rate than Bank of America and Chase, a higher rate than Citi, Wells Fargo, Discover, and it’s a higher rate than American Express, too. If you want to get started earning 5.1% APY on your cash, check out public.com. We can’t say it’s the highest interest rate for your cash, but it’s up there. This is a paid endorsement for public investing, 5.1% APY as of March 26th, 2024, and is subject to change. Full disclosures and terms and conditions can be found in the podcast description, US members only.

I remember the invention of sweet chocolate. I always hated it, but others seem to enjoy it, and that’s what this company is selling. Mary Long and Motley Fool analyst Anthony Schiavone take a look at Hershey’s business and its current headwinds.

Mary Long: When I see the name Hershey, most listeners are probably going to be familiar with the company’s candy business, but there are ambitions beyond candy that this company has. CEO Michele Buck has ambitions to turn the company into a snacking powerhouse. They already own brands that I was at least familiar with: Dot’s Pretzels, PIRATE’S BOOTY, and SKINNYPOP. I know that you’re a fan of Hershey as a company, especially as a dividend investor. What is it that you love about this company?

Anthony Schiavone: Well, I think there’s a lot to love about the Hershey Company. I think the first thing is resiliency. If you go back to the company’s founding in 1894, 130 years ago, by Milton Hershey, this company’s survived wars, depressions, competition, pandemics. It’s still that market leader today. A big reason for that is, like you mentioned, some of the strong brands that it has as everlasting brands. Today, they own more than 100 brands, including Hershey, obviously. REESE’S, KISSES, ICE BREAKERS, the upcoming snacking portfolio, so many well-known brands. That brand equity, which has been built up really of the past centuries, is a key advantage for Hershey. I think one of the reasons why the company generates such high returns on capital. Lastly, and probably most importantly, the management team treats shareholder capital like it’s their own. I’m sure we’ll get into capital allocation later, but as a shareholder of Hershey myself, that’s one thing I really love about this company.

Mary Long: All those brands that you mentioned are really big names in the US, but something that the company is looking increasingly toward is international expansion. When the CEO, again, Michele Buck, when she stepped into the helm at Hershey in 2017, this international segment was losing money, and since then, it started to generate some money. What’s the story behind this turnaround? What was the strategy there, and how did that pan out?

Anthony Schiavone: This might be surprising, but Hershey actually generates less than 10% of its total revenue outside North America. As someone who grew up less than two hours from Hershey, I was shocked when I learned that because Hershey is everywhere in Pennsylvania, international is still really a huge untapped market for the company. Like you said, Michele Buck took over 2017, the international business was losing money, but it is one of our goals to improve that profitability in that segment. The last few years, Hershey’s really just invested in its supply chain to improve capacity, efficiency, and change its go-to market strategy in several countries that were underperforming. Then, lastly, they’ve really just doubled down on marketing their strongest brands, REESE’S and Hershey, in its international markets. The end result is they went from a money-losing business to one that now generates more than 100 million in operating income in 2023. It’s definitely been an impressive turnaround, and I think you’re still riding the growth.

Mary Long: You mentioned that a highlight of a benefit of this company is its resiliency that it’s been around for a while. The flip side of that might be that it’s been around for a while. How much more growth is there that’s possible for Hershey? We mentioned this growing international segment, their new step into snacks. Any growth opportunities here that you see as particularly interesting that might otherwise slide under the radar?

Anthony Schiavone: Well, I think the snacking portfolio and the international expansion are definitely the two big ones. That’s going to move the needle the most for Hershey. Another interesting thing that management recently announced is that they’re starting a new gummy brand that’s coming out late this summer, and Shaquille O’Neil, the Hall of Fame basketball player, he’s going to be a brand ambassador for it. I think that’s interesting. I’m not sure if it’s going to be a huge needle mover for the company, but it’s good to see them continually innovate to new products.

Mary Long: You mentioned the brand equity, like celebrity endorsements, and getting influencers attached to brands is certainly one way to build that out. You mentioned earlier that management treats capital as though it’s their own, and capital allocation has been called out by management as being a big priority for the company. I think you mentioned return on invested capital earlier. Compared to competitors in the same confectionery and snacking space, Hershey blows them out of the water. Hershey’s return on invested capital is about just shy of 24%, whereas take Pepsi; that’s just shy of 15%. There’s a big difference there between competitors. What does Hershey get right about capital allocation?

Anthony Schiavone: I think largely, it comes down to management’s mindset around capital allocation. The CFO, Steve Voskuil, is on record saying that they want to be the best capital allocators in their space. When I read that for the first time, I absolutely loved that. As you mentioned, the results over the last few years have definitely shown that they consistently have industry-leading profitability metrics, returns on capital, and the thing that I love about them is, when they don’t have a high return investment opportunity, they love returning that capital to shareholders through dividends and, more recently, share repurchases, which is interesting. Another thing that management said is that their job is not to warehouse a shareholder’s cash. The cash belongs to the shareholders. If they don’t have a good use of the cash, they’re going to return it to shareholders. I just love their overall mindset around that and how they think about that.

Mary Long: You’ve talked a lot about the things that you love about Hershey, but there are some outside trends that seem like they might be positioned to hurt this business potentially. One which comes to mind is weight-loss drugs. Do you see this growing use of weight-loss drugs as impacting the long-term thesis for Hershey at all?

Anthony Schiavone: It’s a tough question because there’s so much we don’t know yet about GLP-1 drugs, what are the side effects? Will it ever become affordable for the broader population? Even if they are these miracle drugs, what second-order effects will there be on Hershey’s business? Will Hershey have reduced competition since one of the biggest chocolate snacking companies are in their space? Will they somehow have more pricing power, oddly? I think these are questions that we all need to ask, and we just don’t have many answers right now. But if I have to give an answer, I think on the margins, it’ll affect Hershey. But at this point, I don’t think it’s going to have material impact on the company. You think too, like a quarter of the revenue comes from holidays like Halloween, Easter, Christmas. Are people going to stop buying candy at those times? I’m not so sure.

Mary Long: That’s a great point. That so much of candy is less for the food, like sustenance aspect, and more just for the fun, the gift-giving, etc. Does that go away, even in a world where the use of weight-loss drugs just continues to grow? Probably not. Another outside impact that is already potentially having effects on this company is commodities pricing. Cocoa prices are way up. For the most part of the decade, cocoa has cost about $2,500 per metric ton, and it’s been pretty consistent around that price, but last December, it hit $4,200. That number hadn’t been seen since the ’70s in this market. Now it’s nearly double that. Just today, it was over $9,000 per metric ton. It got closer to 12 in mid-April. These are massive spikes. What’s the story here that’s pushing cocoa prices so far up?

Anthony Schiavone: There’s a couple factors that we can talk about, but the main one is really just poor growing conditions in West Africa, which accounts for about 70% of the world supply of cocoa beans. Since demand is outpacing supply, that’s what’s mostly leading to higher cocoa prices. There’s some other factors, like financial speculation, regulation, and just the illiquidity that’s in cocoa markets, that has made things worse. But really, the supply demand deficit is the main factor there.

Mary Long: What’s the fix for this? If these are prices that are unseen for decades, and cocoa is obviously a key ingredient for a chocolate tier to be buying, do you expect these prices to go down anytime soon, or is this something that Hershey and other chocolate makers and candy makers are just going to have to factor into their pricing moving forward?

Anthony Schiavone: Well, I’m going to go back to Hershey’s resiliency that we talked about earlier. High cocoa prices might be new for investors today, but it’s not new for Hershey and some of its competitors. After World War II, cocoa prices spiked. Then in 1970s, like you mentioned, they surged again, so I think Hershey is going to be able to handle this cost inflation just like it did back then. It’s going to handle it today. There’s a few ways they can do that; they can raise prices even more. They’ve already raised prices quite a bit, but they can raise prices further. They have hedging programs in place. They have a lot more scale than a lot of their smaller competitors, so that should help. They have more diverse sourcing options available too. There’s a lot of options that Hershey can use. I think profitability is probably going to be impacted this year, but if you’re a long-term investor, I don’t think this is something we’re going to be talking about in a few years.

Mary Long: The higher cost of cocoa, you mentioned that we might see this impact Hershey’s profitability by the end of the year, but it hasn’t seemed to have had an effect on the company’s margins quite yet. Is that in large part because they are raising prices, or are there other reasons behind that?

Anthony Schiavone: I think that’s probably the main thing they are raising prices in step. I think toward the back half of the year, we might see margins come down. But at the end of the day, the cure for high commodity prices is high commodity prices. Eventually, they’re going to revert to the mean, and when they do, I don’t think Hershey’s going to be so quick to reduce their prices. That’s when we might see margins move higher. They have a lot of cost-saving initiatives that they’re putting in place right now that’s going to have an impact in a couple of years for the company. You have expanding margins because of lower commodity prices in a few years. Then you also benefit from these cost-saving initiatives we’re putting in place now. I think the future looks bright for Hershey.

Mary Long: You think the future looks bright for Hershey; the market might think otherwise; they seem to be down on big chocolate. Hershey’s trading at a discount to the market’s PE ratio. Hershey’s is about 19, whereas the S&P 500 is about 21. Again, I know that you think that good times are ahead for Hershey, but just to put on the opposing cap for a second, what ultimately could go wrong with the Hershey thesis long-term?

Anthony Schiavone: I think when I look at the snacking portfolio, if Hershey really wants to become that snacking powerhouse, I think they’re going to likely need to make an acquisition or maybe even two to get there. SKINNYPOP, Dot’s Pretzels, PIRATE’S BOOTY, they’re all strong brands, but to be a true powerhouse, I think they’re going to need a little bit more. Although management has been top-notch capital allocated so far, I do worry about a major snacking acquisition that might be diluted to the company’s overall brand. That’s one thing I’m watching.

Mary Long: As you’ve mentioned, resiliency is a big part of the Hershey story, and so hopefully for investors like yourself, that continues to be the case. Thanks so much for talking about this with me. Really appreciate having you on the show.

Anthony Schiavone: Thank you. Appreciate it.

Ricky Mulvey: As always, people on the program may have interests in the stocks they talk about, and the Motley Fool may have formal recommendations for or against, so don’t buy yourself anything based solely on what you hear. I’m Ricky Mulvey. Thanks for listening. We’ll be back tomorrow.