microsoft MSFT is scheduled to release its third quarter financial results on April 25th. Morningstar offers its opinion on what to watch for in Microsoft’s earnings and stock price outlook.
Microsoft Morningstar Key Metrics
Financial results announcement date
- After the close of trading on Thursday, April 25th
Points to note in Microsoft’s third quarter financial results
- Azure: It is expected that growth will continue to be flat going forward. If it accelerates by even one point, it is likely to have a significant positive impact on stock prices.
- artificial intelligence: Seek comments on new products and monetization opportunities. I would like to know the impact of AI on dollars and growth rates.
- Office 365: This has been a key growth driver for the past few years and will continue to be important, even if it is currently overshadowed by AI.
- Other areas of note: Watch for commentary on Activision, general commercial demand, and continued recovery in advertising on LinkedIn and Bing.
Microsoft fair value estimate
With our 3-star rating, we believe Microsoft’s stock is fairly valued relative to our long-term fair value estimate of $420 per share, which translates to a fiscal 2024 enterprise value/sales multiple of $420 per share. 12x, meaning an adjusted P/E multiple of 36x. , the free cash flow yield is 1%.
We model compound annual revenue growth of approximately 13% over the five-year period, including the Activision acquisition. However, we believe macro and currency factors will weigh on earnings in the short term. We believe Azure, Office 365, Dynamics 365, LinkedIn, and emerging AI adoption will drive revenue growth. In our view, Azure in particular will be the most important revenue driver over the next decade, as hybrid environments (where Microsoft excels) drive mass cloud adoption. As CIOs continue to consolidate vendors, we believe the combination of Azure, DBMS, Dynamics 365, and Office 365 will drive above-market growth. We believe that personal computing will grow slightly more than GDP over the next decade.
Learn more about Microsoft’s fair value estimates.
Evaluation of economic moat
Microsoft has a wide moat overall that stems from switching costs, network effects, and cost advantages. We believe the company is a leader in a variety of key technology areas and should deliver economic returns far exceeding its cost of capital for many years to come. We believe that Microsoft’s different segments and products benefit from different moat sources.
Microsoft’s Productivity and Business Processes division includes Office, Dynamics, and LinkedIn. Assign a wide moat to this segment based on high switching costs and network effects.
We believe that Microsoft Office (including both 365 and perpetual license versions) is protected by a wide moat due to high switching costs and network effects. Office 365 is a cloud-based version of the traditionally perpetually licensed Microsoft Office productivity suite. Office 365 is available as a monthly subscription. Together, the two products account for approximately 26% of revenue and are growing in low double-digit territory. Office 365 accounts for more than half of Office’s revenue. We expect Office perpetual license sales to continue to decline, both in absolute terms and as a percentage of revenue, with Office 365 growth more than offsetting that decline.
Learn more about Microsoft’s moat ratings here.
financial strength
We believe Microsoft enjoys superior financial strength due to its strong balance sheet, growing revenue, and high margin expansion. As of June 2023, Microsoft had $111 billion in cash and equivalents, offset by $47 billion in debt, resulting in a net cash position of $64 billion. Gross leverage is 0.5x FY2023 EBITDA.
Our base case assumes that revenue will grow at a healthy pace from Azure public cloud adoption, Office 365 upsell efforts, AI adoption, and broader digital transformation efforts. The high profit margin is expected to further improve in the coming years. Free cash flow margins have averaged 31% over the past three years and are expected to generally improve over time.
Learn more about Microsoft’s financial strength.
risk and uncertainty
Microsoft’s risks vary by its products and segments. The high market share of client/server architectures over the past 30 years means that significant high-margin revenues are at risk, especially in the OS, Office, and Server areas. Microsoft has thus far been successful in increasing revenue in an ever-evolving technology environment, both by migrating existing workloads to the cloud for existing customers and by attracting new customers directly to Azure. I’ve been successful in both of those things. However, it must continue to drive revenue growth for cloud-based products faster than revenue declines for on-premises products.
Building public clouds is still in its infancy. Although AWS has dominated the market and Azure has followed suit, these two companies are considered the clear leaders. This is a rapidly evolving market, and Microsoft must continually adjust its products, add solutions to its stack, and compete with companies that are building their businesses with aggressive pricing.
Click here for details Microsoft Risks and Uncertainties.
MSFT bulls say
- Public clouds are widely considered to be the future of enterprise computing. Azure is a key service that will benefit the evolution first to a hybrid environment and ultimately to a public cloud environment.
- Microsoft 365 continues to benefit from upsells to more expensive inventory management units as customers are willing to pay for better security and Teams Phone, and this is likely to continue for years to come.
- Microsoft has dominant positions in various areas (OS, Office) and acts as a cash cow to drive Azure’s growth.
MSFT Bears says
- The continued shift toward subscriptions, especially toward Office, which is generally considered a mature product, is slowing.
- Microsoft lacks a significant mobile presence.
- Microsoft is not a top player in its main growth sources, especially Azure and Dynamics.
This article was edited by Sokhoeun Noeut.
