Why Is Microsoft (MSFT) Up 6.3% Since Last Earnings Report?
It has been about a month since the last earnings report for Microsoft (MSFT). Shares have added about 6.3% in that time frame, outperforming the S&P 500.
Will the recent positive trend continue leading up to its next earnings release, or is Microsoft due for a pullback? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at its most recent earnings report in order to get a better handle on the important drivers.
Microsoft’s Q3 Earnings, Revenues Beat on Cloud Strength
Microsoft reported third-quarter fiscal 2023 earnings of $2.45 per share, which beat the Zacks Consensus Estimate by 10.4% and improved 10.4% on a year-over-year basis.
Revenues of $52.8 billion increased 7.1% year over year and beat the Zacks Consensus Estimate by 3.78%. At constant currency (cc), revenues increased 10% year over year.
Commercial bookings increased 11% and 12% in cc, on a strong prior year comparable, driven by strong renewal execution.
Commercial remaining performance obligation increased 26% to $196 billion. Roughly 45% will be recognized in revenues in the next 12 months, up 18% year over year. The remaining portion, which will be recognized beyond the next 12 months, increased 34%.
Microsoft Cloud revenues were $28.5 billion, up 22% (up 25% in cc) year over year, slightly ahead of expectations. Microsoft Cloud gross margin percentage increased roughly 2 points year over year to 72%, a point ahead of expectations driven by cloud engineering efficiencies.
Top-line growth was driven by improvement in Intelligent Cloud and Productivity and Business Processes, offset in part by a decline in More Personal Computing. Intelligent Cloud revenues increased in the quarter, driven by Azure and other cloud services. Productivity and Business Processes revenues increased due to the Office 365 Commercial. More Personal Computing revenues decreased due to Windows and Devices.
Segmental Details
The Productivity & Business Processes segment, which includes the Office and Dynamics CRM businesses, contributed 33.1% to total revenues. Revenues increased 11% (up 15% at cc) on a year-over-year basis to $17.5 billion, primarily driven by better-than-expected results in Office Commercial.
Office Commercial products and cloud services revenues increased 13% (up 17% in cc), driven by Office 365 Commercial revenue growth of 14% (up 18% in cc). Continued momentum in the small and medium businesses and frontline worker offerings, as well as gain in revenue per user drove top-line growth.
Office Consumer products and cloud services revenues increased 1% (up 4% in cc). Microsoft 365 Consumer subscribers grew to 65.4 million in the reported quarter, up 12% year over year.
Dynamics products and cloud services revenues grew 17% and 21% in cc because of Dynamics 365, which grew 25% and 29% in constant currency, with healthy growth across all workloads.
LinkedIn revenues increased 8% and 10% in cc, driven by growth in Talent Solutions. LinkedIn sessions grew 15% with record engagement.
The Intelligent Cloud segment, including server and enterprise products and services, contributed 41.8% to total revenues. The segment reported revenues of $22.1 billion, up 16% (19% at cc) year over year.
Server product and cloud services revenues rallied 17% year over year (up 21% at cc). Azure and other cloud services revenues grew 27% and 31% in cc.
The enterprise mobility and security installed base grew 15% to over 250 million seats. In on-premises server business, enterprise service revenues increased 6% (up 9% at cc) in the reported quarter with better-than-expected performance across Enterprise Support Services and Microsoft Consulting Services.
Server products revenues decreased 2% and was relatively unchanged in constant currency with continued demand for hybrid offerings, including Windows Server and SQL Server running in multi-cloud environments, offset by weakness in transactional licensing.
More Personal Computing segment, which primarily comprises Windows, Gaming, Devices and Search businesses, contributed 25.1% to total revenues. Revenues decreased 9% year over year (down 7% at cc) to $13.3 billion.
Windows commercial products and cloud services revenues increased 14% year over year (up 18% at cc), primarily due to the strong renewal execution with higher in-period revenue recognition.
Windows OEM revenues were down 28% year over year as elevated channel inventory levels continued to drive additional weakness besides deteriorating PC demand.
Search and news advertising revenues, excluding traffic acquisition costs increased 10% (up 13% at cc), including 2 points from the Xandr acquisition, driven by higher search volume with share gains in the quarter for Edge browser globally and Bing in the United States.
Gaming revenues declined 4% and 1% at cc. Xbox hardware revenues decreased 30% (down 28% at cc). Xbox content and services revenues increased 3% (up 5% at cc) driven by growth in Xbox Game Pass.
Operating Results
Gross profit increased 8.8% year over year to $36.7 billion. The gross margin expanded 110 basis points (bps) to 69.5% on a year-over-year basis.
Microsoft cloud gross margin increased roughly 2 points year over year to 72%. Excluding the impact of the change in accounting estimate for useful lives, Microsoft Cloud gross margin percentage decreased slightly due to lower Azure margin.
Operating expenses increased 7.4% year over year (up 9% at cc) to $14.4 billion. Operating expense growth was driven by roughly 2 points from the Nuance and Xandr acquisitions as well as investments in cloud engineering and LinkedIn.
Operating income was $22.3 billion, up 10% (up 15% in cc) on a year-over-year basis, respectively. The operating margin expanded 100 bps on a year-over-year basis to 42.3%.
Productivity & Business Process operating income rose 20.2% to $8.63 billion. Intelligent Cloud operating income increased 12.9% to $9.47 billion. More Personal Computing operating income declined 11.5% to $4.23 billion.
Balance Sheet & Cash Flow
As of Mar 31, 2023, Microsoft had total cash, cash equivalents and short-term investments balance of $104.4 billion compared with $99.5 billion as of Dec 31, 2022.
As of Mar 31, 2023, long-term debt (including the current portion) was $48.1 billion compared with $48 billion as of Dec 31, 2022.
Operating cash flow during the reported quarter was $24.4 billion compared with $11.1 billion in the previous quarter. Free cash flow during the quarter was $17.8 billion compared with $4.9 billion in the prior quarter.
In the reported quarter, the company returned $9.7 billion to shareholders in the form of share repurchases ($5.4 billion) and dividends payouts ($5.06 billion).
Guidance
For the fiscal fourth quarter, Microsoft expects cost of goods sold to grow between 3% and 4% in cc or to be between $16.8 billion and $17 billion and operating expenses to grow approximately 2% in constant currency or $15.1 billion to $15.2 billion.
Other income and expense are expected to be roughly $300 million as interest income is likely to more than offset interest expense, per company guidance. The company expects fourth-quarter effective tax rate to be 19%. For fourth-quarter cash flow, Microsoft expects to make a $1.3 billion cash tax payment related to the R&D capitalization provision.
For the fiscal fourth quarter, Microsoft expects revenue growth in the productivity and business processes segment between 10% and 12% in cc to a range of $17.9-$18.2 billion. Microsoft expects Office 365 revenue growth to be roughly 16% in cc. In on-premises business, the company expects revenues to decline in the low-30s range.
In Office consumer, Microsoft expects revenue growth in the mid-single digits, driven by Microsoft 365 subscriptions. For LinkedIn, the company expects mid-single digit revenue growth due to Talent Solutions with continued strong engagement on the platform. And in Dynamics, Microsoft expects revenue growth in the mid- to high-teens, driven by continued growth in Dynamics 365.
For Intelligent Cloud, Microsoft anticipates revenues in constant currency to increase between 15% and 16% to a range of $23.6-$23.9 billion. Revenues from Azure can have quarterly variability primarily from per user business and from in-period revenue recognition depending on the mix of contracts.
In Azure, Microsoft expects revenue growth to be 26% to 27% in cc, including roughly 1 point from AI services, driven by Azure consumption business and the company expects the trends from third-quarter to continue into fourth-quarter.
In Enterprise Services, revenues are expected to be relatively unchanged year-over-year as growth in Enterprise Support Services will be offset by a decline in Microsoft Consulting Services.
For more personal computing, the company projects revenues between $13.35 billion and $13.65 billion, pressured by the persistent decline in the personal computer market. The company sees Windows OEM revenues to decline in the low-to-mid 20s range.
Microsoft expects Xbox content and services revenue growth in the low- to mid-teens due to third-party and first-party content as well as Xbox Game Pass.
Key Developments
The company is engaging in a multi-year and multi-billion-dollar investment in OpenAI in an attempt to better tackle competitors including Amazon owned Amazon Web Services (“AWS”) and Alphabet’s Google Cloud.
The investment is expected to help Microsoft further differentiate its cloud offerings from competitors like Amazon and Google. The company has also added the technology to its Bing search engine, a move that could threaten Google’s search dominance.
In thismonth, Amazon’s AWS unveiled an AI-powered solution, Amazon Bedrock. The solution is designed to accelerate the deployment of generative AI-backed foundation models. Further, the company introduced its language model called Amazon Titan.
Meanwhile, Google is also making concerted efforts toward bolstering features of its chatbot, Bard, which is based on the Language Model for Dialogue Applications (LaMDA) and produces blocks of text instantly.
Microsoft’s Azure OpenAI Service brings together advanced models, including ChatGPT and GPT-4 with the enterprise capabilities of Azure. The company stated that it now has more than 2,500 Azure OpenAI Service customers, including the likes of Coursera, Grammarly, Mercedes-Benz and Shell among others, up 10x quarter over quarter. Last week, Epic Systems shared that it was using Azure OpenAI Service to integrate the next generation of AI with its industry leading EHR software.
IKEA Retail, ING Bank, Rabobank, Telstra and Wolverine Worldwide, all use Azure Arc to run Azure services across on-premises, edge and multi-cloud environments. Microsoft has more than 15,000 Azure Arc customers, up more than 150% year over year.
Markedly, 76% of the Fortune 500 use GitHub to build, ship and maintain software. GitHub Copilot, the first at-scale AI developer tool, is also gaining momentum. In three months since Copilot for Business was made broadly available, more than 10,000 organizations have signed up, including the likes of Coca-Cola and GM as well as Duolingo and Mercado Libre, all of which credit Copilot with increasing the speed for the developers.
Teams usage reached an all-time high and surpassed 300 million monthly active users in the reported quarter. The company announced a new version of Teams that delivers up to two times faster performance while using 50% less memory so customers can collaborate more efficiently and prepare for experiences like Copilot.
How Have Estimates Been Moving Since Then?
In the past month, investors have witnessed an upward trend in fresh estimates.
The consensus estimate has shifted 5.35% due to these changes.
VGM Scores
Currently, Microsoft has a nice Growth Score of B, a grade with the same score on the momentum front. However, the stock was allocated a grade of D on the value side, putting it in the bottom 40% for this investment strategy.
Overall, the stock has an aggregate VGM Score of C. If you aren't focused on one strategy, this score is the one you should be interested in.
Outlook
Estimates have been broadly trending upward for the stock, and the magnitude of these revisions looks promising. Notably, Microsoft has a Zacks Rank #3 (Hold). We expect an in-line return from the stock in the next few months.
Performance of an Industry Player
Microsoft belongs to the Zacks Computer - Software industry. Another stock from the same industry, Cadence Design Systems (CDNS), has gained 0% over the past month. More than a month has passed since the company reported results for the quarter ended March 2023.
Cadence reported revenues of $1.02 billion in the last reported quarter, representing a year-over-year change of +13.3%. EPS of $1.29 for the same period compares with $1.17 a year ago.
Cadence is expected to post earnings of $1.17 per share for the current quarter, representing a year-over-year change of +8.3%. Over the last 30 days, the Zacks Consensus Estimate has changed -1%.
The overall direction and magnitude of estimate revisions translate into a Zacks Rank #3 (Hold) for Cadence. Also, the stock has a VGM Score of C.
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