A month has passed since the last earnings report for Microsoft (MSFT). Stocks are up nearly 7% in that period, outperforming the S&P 500.
Will the recent positive trend continue for the next earnings release, or is Microsoft ready for a pullback? Before we dive into how investors and analysts have reacted lately, here’s a look at the most recent earnings report to get a better sense of the key drivers.
Microsoft outperforms Q1, expects slower growth in Azure
Microsoft reported earnings of $2.35 per share for the first quarter of 2023, beating Zacks’ consensus estimate by 2.62% and up 3.5% year-over-year.
Revenue of $50.1 billion increased 10.6% year over year, beating the Zacks Consensus Estimate by 1.32%. On a non-GAAP basis, revenue grew 11% year-over-year and at constant currency (cc) revenue grew 16% year-over-year.
Commercial bookings were down 3% year-over-year and CC grew 16% on a flat maturity basis. Excluding the FX impact, growth was driven by strong renewal execution and an increase in large, long-term Azure contracts.
Commercial balance sheet performance obligations grew 31% year over year and 34% on cc to $180 billion. Approximately 45% of sales will be identified in the next 12 months, up 23% year-over-year. The remainder, which will be recognized after the next 12 months, grew 38% year over year.
Microsoft Cloud revenue was $25.7 billion, up 24% (up 31% in cc) year-over-year, driven by healthy demand in commercial businesses.
The Productivity and Business Processes segment, which includes the Office and Dynamics CRM businesses, contributed 32.8% to total sales. Year-over-year revenue grew 9.5% (up 15% from CC) to $16.5 billion.
Sales from commercial office products and cloud services grew 7% year-over-year (13% higher than CC). Sales of commercial office products were down 28% (down 22% from CC) due to the continued shift of customers to cloud offerings.
Office 365 commercial revenue grew 11% (up 17% from cc), led by a 14% increase in Office 365 business seats. Continued momentum in offerings to small and medium businesses and frontline workers has driven revenue growth. Revenue per user increased in the reported quarter.
Office consumer products and cloud services revenue increased 7% (11% growth vs. CC), driven by growth in Microsoft 365 consumer subscription revenue. The total number of consumer customers of Microsoft 365 was 61.3 million, up 13% year-over-year.
Dynamics products and cloud services business grew 15% year over year (up 22% from CC). Dynamics 365 revenue grew 24% (32% more than cc).
LinkedIn revenue was up 17% from the same quarter last year (21% higher than CC), driven by continued strength in Marketing Solutions and better-than-expected performance in Talent Solutions. LinkedIn sessions grew 24% with record engagement.
The Intelligent Cloud segment, including servers and business products and services, contributed 40.6% to total revenue. The segment reported revenue of $20.3 billion, up 20.2% year-over-year (26% on CC).
Revenue from server products and cloud services grew 22% year over year (28% growth on cc). The highlight was revenue from Azure and other cloud services, which grew 35% year over year (42% more than cc). The uptick was driven by strong growth in consumer-based businesses.
Server product revenue was relatively flat year-over-year (4% higher than in cc), driven by demand for hybrid solutions and Nuance, partially offset by an increase in multi-year agreements compared to the prior year. Consisted of benefit from – Quarterly revenue recognition.
The number of installed enterprise mobility grew by 18% to more than 232 million seats.
Enterprise Services revenue grew 5% in the reported quarter (up 10% from CC) driven by growth in Enterprise Support Services.
The larger Personal Computing segment, which mainly includes the Windows, gaming, devices and search businesses, contributed 26.6% to total revenue. Revenue was down 0.3% year over year (up 3% from cc) to $13.3 billion due to declines in Windows, partially offset by growth in search and news advertising.
Revenue from commercial Windows products and cloud services grew 8% year over year (up 15% from CC) as a result of increased customer adoption of Microsoft 365 offerings.
Windows OEM revenues were down 15% year over year due to the deteriorating PC market, partially offset by a 5 point positive impact from last year’s Windows 11 revenue referrals.
Excluding traffic acquisition costs (TAC), search and news advertising revenue grew 16% (21% growth on cc), driven by higher search volume and Xandr.
Gaming revenue was up 4% on CC. Xbox content and services revenues were down 3% (up 1% from cc) due to fewer hours and increased revenue due to a decrease in third-party and first-party content, partially offset by a increase in Xbox Game Pass subscriptions. Xbox hardware revenue was up 13% (up 19% from cc).
Xbox content and services revenue was down 3% year over year (1% higher than cc).
Gross profit grew 9.5% year over year to $34.6 billion. Gross margin was 69.2%, down 70 basis points (bps) year-over-year.
Microsoft Cloud gross margin increased nearly 2 points year over year to 73%. Microsoft Cloud gross margin percentage declined by approximately 1 point, primarily due to a shift in the sales mix in Azure and a lower Azure margin due to higher energy costs, excluding the impact of the change in accounting estimate for the useful life.
Operating expenses increased 15% year over year (up 18% from CC) to $13.1 billion due to investments in cloud engineering, LinkedIn, Nuance and commercial sales.
Operating income grew 6% year over year (15% growth on cc). The operating margin contracted 170 basis points to 42.9% year-over-year.
Productivity and business process operating income grew 9.8% to $8.3 billion. Intelligent Cloud operating income grew 16.9% to $8.9 billion. More Personal computing operating income fell 15.3% to $4.2 billion.
Balance sheet and cash flow
As of September 30, 2022, Microsoft had total cash, cash equivalents, and short-term investments of $107.2 billion, compared to $104.7 billion as of June 30, 2022.
As of September 30, 2022, long-term debt (including the current portion) was $48.5 billion, compared to $49.7 billion as of June 30, 2022.
Operating cash flow during the reported quarter was $23.1 billion compared to $24.6 billion in the prior quarter. Free cash flow during the quarter was $16.9 billion compared to $17.7 billion in the prior quarter.
In the reported quarter, the company returned $9.7 billion to shareholders in the form of share repurchases ($5.5 billion) and dividend payments ($4.6 billion).
For the fiscal second quarter, Microsoft posted bearish guidance in its cloud computing business as major customers curb spending in the face of a slowing economy, sending its shares down 7% in aftermarket trading.
The cautious comment raised hopes that continued solid demand for cloud services would offset a slump in the PC market and help the world’s largest software company weather broader pressures in the IT market.
Microsoft warned that revenue growth from Azure, the cloud computing platform that has become one of its company’s main engines, would have slowed by 5 percentage points in the fiscal second quarter, excluding the effect of currency fluctuations.
For the fiscal second quarter, Microsoft expects revenue growth in the Productivity and Business Processes segments to be between 11% and 13% cc between $16.6 billion and $16.9 billion.
For Intelligent Cloud, Microsoft estimates revenue to grow between 22% and 24% to $21.25 billion and $21.55 billion in constant currency. The company sees Azure’s constant currency growth decline sequentially by 5 percentage points.
For more personal computing, the company expects revenue between $14.5 billion and $14.9 billion, pressured by a sharp decline in the PC market. The company sees Windows OEM revenues drop around 30%.
Microsoft expects revenue from Xbox content and services to decline by low to mid-single digits.
Management expects the cost of sales to be between $17.4 billion and $17.6 billion. Operating costs are estimated to be between $14.3 and $13.4 billion.
How have the estimates progressed since then?
As it turns out, the latest estimates have fallen over the past month.
These changes have increased the consensus estimate by -8.86%.
Currently, Microsoft has a strong growth score of A, although it lags far behind on Momentum Score with a D. After the same price, the stock was assigned a grade of D on the value side, it was dropped. A drop of 40% for this investment strategy.
Overall, the stock has an overall VGM score of B. If you’re not focusing on a strategy, this score should be what you should be interested in.
Estimates for the stock are broadly trending downwards, and the magnitude of these revisions points to a downward shift. It’s no wonder Microsoft has a Zacks Rank #4 (Sales). We expect below-average returns from this stock in the coming months.
Performance of an industry player
Microsoft is part of the Zacks computer software industry. Over the past month, Cadence Design Systems (CDNS), a stock in the same industry, is up 12.4%. The company reported its results for the quarter ending September 2022 more than a month ago.
Cadence reported revenue of $902.55 million in the last reported quarter, a +20.2% year-over-year change. EPS of $1.06 compared to $0.80 a year ago for the same period.
For the current quarter, Cadence is expected to post earnings per share of $0.91, marking a +11% change from the year-ago quarter. Zacks’ consensus estimate has remained unchanged for the past 30 days.
The general direction and magnitude of estimate revisions translates to a Zacks Rank #3 (Hold) for cadence. The stock also has a VGM score of C.
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Jax Investment Research