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Morningstar | Microsoft Reports Good End to Year; Broad-Based Growth Across the Firm; Shares Modestly Undervalued. See Updated Analyst Note from 20 Jul 2018

Microsoft reported a good end to the fiscal year with the company reporting strong constant currency growth across all three key business segments (includes productivity and business processes, intelligent cloud, and more personal computing). We continue to see healthy demand for Microsoft's Office 365, Dynamics 365, and LinkedIn offerings, while the shifting IT infrastructure and consumption preferences of enterprises is expected to spur strong ongoing growth for the firm's server and cloud-based products and services. Notably, we see Azure as having carved out a position as a global public cloud leader, which will help drive the Azure segment into Microsoft's largest business over the next 10 years. With our rosy long-term outlook unchanged after the quarter and full-year, we reiterate our $122 fair value estimate and wide economic moat rating. With shares up in after-hours trade and approaching 3-star territory, for potential investors, we see only a modest margin of safety in the name.

For the quarter, revenue rose 17% year over year to $30.1 billion (increased 15% in constant currency). In constant currency, the firm's commercial cloud revenue surged 50% year over year to $6.9 billion and was led by strong growth in Office 365, Dynamics 365, and Azure. Microsoft's management team noted that they were seeing optimistic corporate IT spending and increasing demand for cloud services.

As the firm's clients' commitment to the cloud increases, we foresee larger and longer-term deals which we think will continue to drive consistent, profitable growth for the firm. To that end, in fiscal 2018, the company closed a record amount of multimillion-dollar commercial cloud deals and roughly doubled their $10 million-plus Azure deals (the firm's annuity mix also increased 300 basis points year over year to 89%). Within more personal computing, good growth was supported by broad-based demand across Windows, Devices, Gaming, and Search highlighting the wide-ranging health of Microsoft's current portfolio of products and services.

On the margin front, Microsoft's gross margin expanded about 100 basis points year over year to 68%, while its operating margin grew approximately 450 basis points year over year to 34.5%. The margin performance was driven by a notable improvement in commercial cloud gross margins which grew roughly 600 basis points year over year to 58%. Still, the company continues to invest in cloud engineering, sales capacity, and LinkedIn. For the coming year, we expect some modest operating margin expansion as the firm's top-line growth outstrips its predicted spending growth.