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Factors Expected to Influence Microsoft's (MSFT) Q2 Earnings

Zacks Equity Research

Microsoft Corp. MSFT is scheduled to report second-quarter 2019 results on Nov 30. Notably, the company’s earnings outpaced the Zacks Consensus Estimate in the trailing four quarters, delivering average positive surprise of 11.9%.

The company reported first-quarter fiscal 2019 earnings of $1.14 per share, which beat the Zacks Consensus Estimate by 18 cents. The figure jumped 35.7% on a year-over-year basis.

Revenues of $29.08 billion increased 18.5% from the year-ago quarter (up 18% in constant currency or cc). Further, the figure exceeded the Zacks Consensus Estimate of $27.73 billion.

What to Expect?

For the second quarter of fiscal 2019, commercial unearned revenues are expected to grow 19% year over year, while commercial cloud gross margin is anticipated to improve at a moderate pace.

Productivity and Business Processes revenues are expected between $9.95 billion and $10.15 billion, driven by double-digit growth in Office commercial and Dynamics. Office is expected to witness continued momentum in new subscriber growth.

Intelligent Cloud revenues (including GitHub) are expected between $9.15 billion and $9.35 billion. Azure's revenue growth is likely to reflect continued strength in the consumption and per-user based services.

More Personal Computing revenues are expected between $12.8 billion and $13.2 billion. OEM Pro revenues are expected to grow in line with the commercial PC market. Surface revenues are expected to grow faster benefiting from recently launched devices, including Surface Pro 6 and Surface Laptop 2.

The Zacks Consensus Estimate for earnings is currently pegged at $1.09 per share, representing an increase of 13.5% year over year. Further, the Zacks Consensus Estimate for revenues is currently pegged at $32.45 billion, representing an increase of 12.2% year over year.

Microsoft shares have returned 15.6% year over year, substantially outperforming the industry’s rally of 10.3%.

Let’s see, how things are shaping up prior to this announcement.

Factors to Consider in Q2

Azure & AI: Key Catalysts

Momentum in Microsoft’s cloud computing service — Azure — is likely to drive growth in the to-be-reported quarter. Azure revenues soared 76% at constant currency on a year-over-year basis in the last reported quarter.

The company added almost 100 new capabilities to Azure in the last reported quarter, with focus on existing workloads like security and new workloads like Internet of Things (IoT) and Edge artificial intelligence (AI). Azure’s clientele continues to expand with Volkswagen, Anheuser-Busch In Bev and Mastercard selecting the cloud platform.

Notably, Azure has become a preferred partner for government departments in recent times. Microsoft clinched a five-year contract from the U.S. Department of Defense (“DoD”), under which the company will provide enterprise services for the Pentagon Defense Department, cloud Coast Guard and intelligence services.

Per the deal, Microsoft will provide enterprise services that include availability of Azure in order to create new technology and address ethical issues.

Further, Microsoft is leaving no stone unturned to integrate robust conversational artificial AI capabilities across its portfolio. The company’s focus on making the utilization of AI easy and available for enterprises is in sync with the acquisition of XOXCO.

Further, Microsoft and LG Electronics inked a deal, per which, Microsoft’s Azure cloud platform and robust AI capabilities will be utilized by LG to enhance its self-driving software.

The strategic alliance is primarily aimed at capitalizing on growth prospects of the emerging Advanced Driver Assistance Systems (“ADAS”) market. Further, Microsoft’s drive to integrate AI capabilities in Azure cloud, positions it well to gain an edge over peers, such as Amazon’s Amazon Web Services (AWS) and Alphabet’s GOOGL Google Cloud et al.

Intelligent Cloud segment reported revenues of $8.57 billion, up 23.8% (same at cc) year over year. Enterprise service revenues increased 6% (same at cc) in the last reported quarter, due to growth in premier support services and Microsoft consulting services.

Office 365: A Notable Growth Driver 

Microsoft is firing all cylinders to catch up with Alphabet’s G-Suite by empowering Office 365. In the last reported quarter, Office 365 commercial revenues grew 36% (35% at cc), driven by strong installed base growth and average revenues per user (ARPU) expansion. Office 365 Commercial seat improved 29% on a year-over-year basis. Office 365 consumer subscribers were reported at 32.5 million, up 1.1 million sequentially.

Notably, Office 365 revenues are reported under Productivity & Business Processes segment. The segment revenues of $9.77 billion increased 18.6% (up 18% at cc) from the year-ago quarter.

The company recently acquired FSLogix in a bid to gain desktop virtualization capabilities to enhance Office 365 suite. Microsoft also announced a discount of $50 on select Xbox One S and Xbox One X variants for a limited time period. The company also expanded its Surface family just before holiday shopping season by introducing Surface Laptop 2, Surface Pro 6 and Surface Studio 2 devices and smart Surface Headphones.

Expanding portfolio is the major growth driver. The company is incorporating AI capabilities in its Office 365 solutions, which are expected to boost adoption rate.

What the Zacks Model Unveils

According to the Zacks model, a company with a Zacks Rank #1 (Strong Buy), 2 (Buy) or 3 (Hold) has a good chance of beating estimates if it also has a positive Earnings ESP. The Sell-rated stocks (Zacks Rank #4 or 5) are best avoided.

Microsofthas a Zacks Rank #2 and an Earnings ESP of 0.00%. You can uncover the best stocks to buy or sell before they’re reported with our Earnings ESP Filter.

Stocks with Favorable Combination

Here are a few stocks that are worth considering as our model shows that these have the right combination of elements to deliver an earnings beat in the upcoming releases.

Caterpillar Inc. CAT has an Earnings ESP of +0.30% and a Zacks Rank #2.You can see the complete list of today’s Zacks #1 Rank stocks here.

Illumina, Inc. ILMN has an Earnings ESP of +0.32% and a Zacks Rank #2.

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