Microsoft Earnings Expectations – Seeking Alpha

Introduction

Microsoft (MSFT) is a household name and one of the largest companies by market capitalisation in the world. The company is trading at an all-time high of $78.81 on the back of big successes such as Azure and the business model switch towards subscription services and recurring revenue that we wrote about in June. On Thursday, Microsoft will release its first-quarter earnings report. Today, we will discuss what to look for in the earnings results, the outlook for the future and provide a valuation model that we will be able to use to compare to results after the announcement.

Overview

Microsoft develops, licenses, and supports software products, services, and devices worldwide. The company is split into three segments. Productivity and Business Processes offers Office 365 commercial and consumer products and services and the LinkedIn online professional network. Its Intelligent Cloud segment licenses server products and cloud services, such as Microsoft SQL Server, Windows Server, as well as Azure, which now has the second largest share of the public cloud. The company’s More Personal Computing segment comprises Windows OEM, volume, and other non-volume licensing of the Windows operating system along with devices, including Microsoft Surface and phones, as well as search advertising, including Bing and Bing Ads. This segment also provides gaming platforms, including the Xbox brand.

In its last earnings report, Microsoft outdid market expectations on the back of the extremely strong continued performance of Azure and the cloud. It achieved non-GAAP revenue of $24.7 billion and GAAP earnings per share of $0.83, above expectations of $24.3 billion and $0.71 respectively.

Azure and The Cloud

In our previous Microsoft article, we wrote about clever strategic advantages of Microsoft’s focus on Azure, we said:

IaaS is the base level of infrastructure. It provides access to physical data centres, networking tools and firewalls and, ultimately, the server and storage space that the cloud runs on. PaaS is the platforms; these are the online versions of traditional operating systems, and developer environments from which applications can be created and deployed. In the Microsoft model, Microsoft Azure is the base for these two parts. SaaS is the software applications that the end user sees and interacts with, things like Office 365 and SharePoint in the Microsoft toolkit.(Source: Microsoft)

Microsoft’s advantage is that it has aggressively fostered all three parts. Nadella refers to this end-to-end offering as ” the entire digital estate“, and it’s clear that this has been a conscious strategic decision. Microsoft Azure forms the centrepiece for enterprise customers that want scalable, secure infrastructure and a developer environment that’s incredibly flexible. But most importantly, it’s the IaaS and PaaS that’s most compatible with Microsoft’s steady performer in Office and its latest 365 iteration.

The strategy seems to be working already, as borne out in the data. Amazon Web Services (AWS), which has enjoyed exceptional profitability and an early lead in the IaaS space, has seen its growth stall. The Kleiner Perkins Internet Trends 2017 Report shows that despite still being the leader in cloud-based applications, their user numbers remained stationary at 57% between 2016 and 2017. Microsoft Azure’s, on the other hand, increased a massive 70% over the same time period, from 20% to 34% of cloud users.

We also wrote about how this boded exceptionally well for the future, with Azure being an extremely machine-learning friendly space.

What to Look For

It will be no surprise then with Microsoft’s shifting emphasis toward the cloud as the centerpiece for the Microsoft product suite, that we recommend looking at continued Azure growth as a success barometer in the upcoming earnings report.

Quicken Loan, KeyCorp (NYSE:KEY), FedEx (FDX) and Progressive Corp. (PGR) have all chosen Microsoft in recent times, and it will be worth watching the impact of these key acquisitions on overall figures.

Microsoft has stated that they are on track to have more than $20 billion in cloud revenues by fiscal 2018. It will be interesting to note whether they have been able to achieve this round target.

Whilst PC sales have continued their decline over recent years, half a billion devices still run Windows 10. Watching how quickly Personal Computing revenues fall will be another key metric to success as if Microsoft is able to slow the bleeding in this area, the narrative will more easily coalesce around their growth segments.

In terms of dividends, Microsoft has raised theirs every year for the past 15 years. Last year’s increase of 8.33% was meagre compared with double-digit rises for the few years prior. This will be another key area to see whether Microsoft continues the decline or is able to once again return to significant dividend increases.

Valuation

We have used a reverse DCF to calculate that the current price would require a 15.07% growth rate over the next 10 years to justify the current price of $78.78. Looking to the most recent Q4 results, revenue increased only 9% year on year. Non-GAAP Diluted Earnings Per Share rose 42%, a mammoth increase. According to Zacks Investment Research, forecasts have coalesced around an EPS figure of $0.73 for the quarter.

Once we have the latest earnings on Thursday, we will be able to compare against these figures to see if Microsoft is on track to hit this target of 15.07% growth, or if the 26% run the company has been on over the year to date has left its stock price pumped up and overvalued.

Conclusion

Microsoft has been on a strong run in recent times and investors should be wary pre-earnings release that the numbers will have to look very good for this to continue. Watching the figures for Azure to see if it can continue its growth trend, as well as whether it can turn this increasing market share into cash, will be the key to dissecting the coming earnings report. Plotting this against the pace at which Microsoft is slowing its declining sales in more traditional areas will provide a roadmap for the future ahead.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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