EUR 850.00 For Business Accounts Only

Morningstar | Microsoft 2Q Slightly Underwhelms; Hybrid Cloud Provides Growth Runway; Shares Undervalued

Microsoft reported results that fell modestly short of our and consensus expectations, with revenue in line and EPS light due to several nonoperating factors including a slightly higher tax rate, a slightly higher share count, and slightly lower other income. Overall, results continue to reinforce our thesis, centering around customer adoption of hybrid cloud environments with Azure. Adoption of cloud services in the form of SaaS, PaaS, and IaaS remains strong for Microsoft, and the company has now passed inflection points where cloud revenue continues to accelerate and margins improve. Revenue growth in the intelligent cloud segment, which contains Azure, accelerated year over year for the ninth consecutive quarter. Microsoft continues to use its dominant positions of on-premise architecture to allow customers to move to the cloud easily and at their own pace. We believe this theme will continue in the foreseeable future. Shares are down 2% in the after-market after finishing the day up 3%, which seems appropriate given generally in line to slightly light results and guidance. We maintain our $130 fair value estimate and wide moat rating after these results.

For the fiscal second-quarter, revenue grew 12% year over year to $32.5 billion, while EPS was $1.08 compared with a loss of ($0.82) a year ago. Productivity & business processes and intelligent cloud were modestly better than expected, with Azure up 76% year over year.  More personal computing was slightly light in our view and offset strength in the other segments. Lower Windows revenue was driven by lower PC volumes, which was driven in turn by a shortage of chipsets.

In line with our thesis, operating margins continue to expand as Microsoft’s cloud-driven offerings scale. This quarter, overall gross margins were flat year over year as rapidly improving commercial cloud gross margins, which were up 500 basis points year over year, were offset by a mix shift to cloud, which still has gross margins below the corporate average, and higher surface and Xbox hardware within the total revenue mix. Operating margin expanded by 150 basis points year over year, with leverage coming from lower sales and marketing, and general and administrative outlays. We think there is more room to run, as recent historical peaks in gross and operating margins suggest 1,000 and 700 basis points, respectively, of expansion is possible in the coming years according to our model.

Next quarter’s guidance for revenue of $29.4 to $30.0 billion bracketed consensus and is generally in line with our expectations. Considering all other elements, guidance implies an EPS range of $0.97 to $1.00, which is slightly light. Foreign exchange has worsened and the company expects chip shortages in PCs to drive lower Windows volumes for at least the next quarter. We view this as transitory and less important than the ongoing shift to the cloud driven by Azure, Dynamics 365, LinkedIn, and Office 365, which should continue to play out for years to come.