In the dynamic realm of cloud computing, Microsoft Corp. (NASDAQ:MSFT) is charting an ambitious course towards a $575 target by 2024, supported by Azure's striking revenue growth, strategic artificial intelligence integration and increasing market dominance.
As the cloud market evolves and the U.S. economy experiences shifts, Azure's performance stands out, underscoring Microsoft's prowess in the sector. This growth story is not just about numbers; it's a testament to Azure's integral role in the Intelligent Cloud segment, with revenue soaring to $24.3 billion in the first quarter of fiscal 2024.
This narrative delves into how Microsoft's forward-looking investments and robust service portfolio position Azure as a long-term player in the cloud market amidst an ever-changing economic landscape.
Azure is a long-term game
Azure's revenue growth has been a standout factor for Microsoft, consistently showcasing impressive numbers. In the first quarter, the Intelligent Cloud segment recorded revenue of $24.3 billion, representing a remarkable 19% increase year over year, primarily propelled by Azure (up 21%).
Moreover, the broader Microsoft Cloud revenue reached an impressive $31.8 billion, surging 24%. Over the long term, Intelligent Cloud's revenue boosted by 17% in 2023 year-over-year to $88 billion. Intelligent Cloud represents 41.5% of Microsoft's total revenue in 2023 as compared to 37.8% in 2022, signifying its growing vitality in Microsoft's topline.
Additionally, the consistent revenue growth also reaffirms Azure's strong market presence and demand for cloud services. The software's rapid expansion aligns with the global shift toward cloud computing. Microsoft's ability to capitalize on this trend by offering a comprehensive suite of cloud solutions has significantly contributed to Azure's revenue surge. Therefore, the company's consistent investments in the infrastructure, robust service offerings and technological advancements have solidified its market position.
Favorably, Azure holds a 23% share of the global cloud market as of the third quarter, up from nearly 21% in the prior-year period. Azure's continuous market share gain proves its ability to attract more organizations to migrate their workloads to Microsoft's cloud.
Further, Microsoft's substantial investments (of $11.2 billion) in scaling AI across Azure services signify its strategic focus on leveraging the technology. Integrating AI across various layers of the tech stack drives productivity gains and operational efficiency for clients. The company's collaborations with giant AI entities like OpenAI, Meta Platforms (NASDAQ:META) and Hugging Face further solidify its AI capabilities.
Azure's versatility is reflected in its diverse clientele across various sectors, such as health care, finance, manufacturing and technology. Notable companies like PepsiCo (NASDAQ:PEP), Vodafone (NASDAQ:VOD), Atrium Health, Northwestern Medicine and SingHealth leverage Azure's capabilities, showcasing its relevance across different industries.
For instance, introducing specialized solutions like Dragon Ambient eXperience in health care exemplifies Microsoft's focus on developing industry-specific solutions. Also, the company's success in catering to specific sectors, such as finance, by offering solutions for migrating Oracle (NYSE:ORCL) databases to Azure highlights its strategic partnerships.
Additionally, Azure's capability to support SAP (NYSE:SAP) workloads for companies like Brother Industries (BRTHY), Hanes (NYSE:HBI), and ZEISS (CZMWF) further emphasizes its reliability and versatility in handling enterprise-level cloud services.
At the bottom line, the improvement in Microsoft Cloud's gross margin percentage to 73% in the first quarter signifies Azure's ability to generate significant returns. Fundamentally, the improvement, excluding accounting estimate changes, reflects the platform's ability to manage costs and enhance profitability while catering to escalating cloud demand.
Finally, despite scaling AI infrastructure to meet growing demand, Azure showcased improved margins, a critical factor in sustaining profitability while expanding services. As a result, Intelligent Cloud's operating income boosted by 14% during 2023 over 2022's levels.
Last but not least, Microsoft's forward approach and focus on investing in cloud and AI opportunities while focusing on operational efficiency bode well for Azure's future growth. Expectations of sustained revenue growth of 17% to 18% year over year for Intelligent Cloud in second-quarter 2024 ($25.1 billion to $25.4 billion) indicate a robust trajectory for Azure's expansion (26% to 27% revenue growth year over year). Overall, anticipating stable Azure revenue growth supported by new workload trends and increased AI contributions signifies the platform's potential for consistent growth.
Fundamental dominance in the cloud market
Azure's substantial market share and growth are derived from its diversified cloud services, such as infrastructure-as-a-service, platform-as-a-service (PaaS) and software-as-a-service (SaaS).
2024 IT spending may increase by 8% year over year to hit $5.1 trillion globally. Especially based on increased cloud spending (due to increased prices and utilization), investments in the software and services segments may experience double-digit growth. To be specific, spending on data center systems may experience growth of 9.5% in 2024.
Although generative AI is not expected to impact IT spending positively until 2025, the present focus lays the groundwork for future developments. As mentioned earlier, Microsoft has heavily invested in AI research and development, integrating the software's capabilities into its products and services to absorb the potential impact.
Notably, global public cloud end-user spending may follow a rapid growth trajectory, nearly 20% year over year, with estimates climbing from $563.6 billion in 2023 to an anticipated $678.8 billion in 2024. This surge is primarily attributed to cloud vendor price increases and increased utilization. Hence, as cloud spending rises, Microsoft's Azure capitalizes on this trend.
Fundamentally, the cloud market's segmented growth reveals specific areas poised for substantial expansion. IaaS is expected to lead in end-user spending growth, projected at an impressive rate of 26.6% in 2024 and PaaS follows, with a forecasted growth rate of 21.5%. Thus, Microsoft's diversified service portfolio, including Azure Virtual Machines, Azure Kubernetes Service and Azure App Service, positions it strategically to capture growth in these high-growth segments.
Additionally, the prominence of industry cloud platforms is a pivotal trend. Gartner predicts that by 2027, over 70% of enterprises (compared to less than 15% in 2023) will leverage industry cloud platforms to accelerate growth. These platforms amalgamate SaaS, PaaS and IaaS services to meet industry-specific demands, aligning perfectly with Microsoft's strategy.
Thus, Microsoft's recognition as a leader in the Gartner Magic Quadrant for Distributed Hybrid Infrastructure underscores its strength in providing cloud-native infrastructure attributes for distributed deployments. Azure Arc, Azure Kubernetes Service and Azure Stack HCI demonstrate Microsoft's focus on delivering adaptable, unified control plane solutions across diverse deployment scenarios.
Finally, this leadership status solidifies the company's reputation and competence in facilitating distributed infrastructure, enhancing its attractiveness to businesses seeking flexible and scalable cloud solutions. As a result, it may continue to benefit Microsoft's revenue growth over the long term.
Downside lies in macroeconomic outlook
On the downside, due to the industry's focus on cost control, operational efficiencies, capital restrictions (due to weak stocks and bonds) or margin issues, the majority of CIOs are experiencing change fatigue, hesitating to invest in new projects and initiatives, which could lead to a delay in IT spending that may extend into 2025.
Therefore, the forecasts suggest business investment may experience a relatively low growth rate of 1.75% in 2024. However, despite this trend, Microsoft's diverse portfolio across software, cloud services and AI positions it as a resilient player in an environment where businesses might delay investments in new projects.
On the positive side, according to Goldman Sachs, there are expectations for a further decrease in inflation pace in 2024 (to reach 2.5% to 3%). Reduced inflation may positively affect business spending, potentially freeing up resources for investment to upgrade their IT infrastructure.
Finally, the U.S. economy is now attached to a lower probability of recession in 2024, 15% in third-quarter 2023 compared to 35% in the first quater, due to positive trends in inflation and the labor market.
Source: Goldman Sachs
Technical take: Targeting $575 by 2024
Microsoft's stock price experienced a rapid recovery and new highs during October and November. However, the formation of the Doji candle signifies market indecision, which may lead to prices going in either direction.
On the downside, the price may hit the pivot level at $347 by the end of 2023 or, in the case of a Santa Claus rally, it may reach $416. Any negative development or most pessimistic scenario may hit the dynamic support level (52-week exponential moving average) at $307.
On the upside, the price may hit $575 (derived from Fibonacci retracement) by the end of 2024 based on current momentum. Most importantly, the 52-week EMA may be a navigator during the trend. Collectively, moving averages signal a strong buy state for the stock price.
Assessing the relative valuation, at the current price-earnings ratio of 36, Microsoft's stock is fairly valued compared to U.S. cloud peers. On an absolute basis, Microsoft's stock is modestly overvalued by around 13% relative to the historical average (five years) price-earnings ratio of 32. Therefore, new bulls can take advantage of possible downward moves in the stock price that may follow the formation of the Doji candle.
Despite potential macroeconomic challenges, Microsoft's diverse portfolio, including software, cloud services and AI, positions it as a resilient contender in the industry. The anticipated decrease in inflation and a lower probability of recession in 2024 could further bolster business investment in IT infrastructure, benefiting Microsoft's Azure platform.
This article first appeared on GuruFocus.