Microsoft's stock drop of 28% so far in 2022 amid growth concerns now looks overdone, Morgan Stanley says.
"While investors worry forward numbers have not been de-risked, we see a strong (and durable) demand signal in the commercial businesses, which should lead to improving revenue and EPS growth in 2H23," Morgan Stanley analyst Keith Weiss wrote in a note on Tuesday.
As a result, the valuation of the tech giant is too cheap to ignore, Weiss contended.
"Trading at ~20x CY24 GAAP earnings, accelerating EPS growth should bring investors back to the name," Weiss added.
Here are more details on Morgan Stanley's defense of Microsoft stock:
Rating: Overweight (reiteration)
Price Target: $307 (raised from $296)
Fiscal Year 2023 EPS Estimate: $9.51 (consensus: $9.55)
Weiss acknowledged investors have valid concerns about the near-term path of Microsoft's growth based on current economic conditions.
"Near-term investor concerns around Microsoft typically fall into two categories," Weiss said, "margins and revenue growth – or more specifically: 1) a larger than expected operating expense guide into Q2, signaling an unwillingness by management to cut expenses and better protect operating margins, and 2) a revenue guidance for durable 20% constant currency (cc) commercial growth that does not appear de-risked (particularly given commercial grew 22% cc in Q1). From our perspective, the two investor concerns go hand in hand."
However, Weiss's research found that demand for Microsoft remains solid.
"Digging deeper, there are multiple factors leading us to believe the commercial business should be more durable than feared for Microsoft, despite the near term macro pressures," the analyst said.
He listed these as:
"Demand signals remain positive, with management conversations, earnings commentary, channel work, and our CIO survey supporting 20% commercial growth."
Operating expenses should normalize into the back half of fiscal year 2023: "Although operating expenses continued to rise into 2QFY23, this is largely due to prior hiring, M&A and rising compensation expenses exiting FY22. With a pause in hiring, operating expense growth should moderate significantly in the back half as we anniversary the more aggressive hiring – we model 15% year over year operating expense growth in 1HFY23 dropping to 8% year over year in 2HFY23."
"Several revenue tailwinds heading into 2HFY23. Less onerous incremental foreign exchange impacts so far this quarter, which should fade further into the back half, ramping O365 pricing benefits, as well as, easier comparisons for Windows OEM, Office Commercial, LinkedIn and Dynamics heading into 2HFY23 should all support more robust top line growth."
"Valuation remains favorable. At ~20x2024 EPS, or ~1.2x 2 years price-to-earnings growth, Microsoft trades at a discount to its historical trading range, other large cap software peers, as well as other mega-cap tech names."