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Microsoft: Why Investors Expect Upbeat Earnings

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Microsoft (MSFT) is scheduled to report its earnings for the first quarter of fiscal 2020 after the closing bell on Wednesday. We expect the company to post upbeat earnings due to the positive estimates revision in the last 60 days.

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Microsoft’s past earnings 

Notably, the company delivered better-than-expected earnings in the past four quarters. Microsoft also reported double-digit revenue growth for the past nine consecutive quarters.

In the fourth quarter, Microsoft reported better-than-expected numbers. The adjusted EPS of $1.37 beat the Zacks Consensus Estimate of $1.21 per share in the fourth quarter. Revenues of $33.72 billion also beat the consensus estimate of $32.73 billion. The earnings and revenues grew 21% YoY and 12% YoY. On a constant currency basis, the earnings increased 24%, while the revenues rose 14% in the fourth quarter due to Microsoft’s major business segments.

Microsoft’s Productivity and Businesses segment grew 14% YoY in the fourth quarter due to its strong growth in Office and Dynamics commercial products. The More Personal Computing segment grew 4% YoY due to the improved performance in the company’s Windows and Surface businesses. However, the Intelligent Cloud business segment grew 19% YoY due to server products and cloud services.

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Microsoft’s earnings expectations 

Microsoft expects to generate total revenues of $31.7 billion–$32.4 billion. The average revenues are $32.05 billion—lower than revenues of $33.72 billion in the previous quarter. The currency is expected to dent the total revenue growth by around two percentage points in the first quarter. The company also expects the cost of goods sold to rise to $10.55 billion–$10.75 billion. Microsoft has spent $5.3 billion in the first quarter—higher than the capital spending in any of the previous quarters.

Analysts expect Microsoft’s earnings to grow 9.23% YoY in the first quarter. Analysts also expect the company’s earnings growth to fall to 10.4% in fiscal 2020—down from 22.4% in fiscal 2019. Meanwhile, the company’s earnings growth rate will likely improve to 13.5% in fiscal 2021.

Analysts expect the company’s first-quarter revenues to grow 10.8% YoY. For fiscal 2020, the revenue growth will likely be 11.1% YoY—down from 14% in fiscal 2019. Analysts expect Microsoft’s revenues to grow 11.2% YoY in fiscal 2021.

We think that Microsoft’s first-quarter earnings results might continue to gain from Azure—its cloud computing service. The company’s Office and Dynamic business will likely drive its revenues in the first quarter. We’ll discuss the factors that could drive Microsoft’s first-quarter earnings results.

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Azure is Microsoft’s driving force

Microsoft’s revenues from its Azure division rose 64% YoY or 68% in constant currency in the last reported quarter.

The company is witnessing higher demand from customers for hybrid cloud offerings, which would boost the revenues. According to research firm Gartner, the worldwide public cloud services market will likely grow from $182.4 billion in 2018 to more than $331 billion by 2022. Higher cloud growth might be due to companies investing more in the cloud. Gartner expects cloud system infrastructure services or infrastructure-as-a-service to be the fastest-growing market segment. According to the IDC, worldwide spending on public cloud services will more than double in 2023. The IDC expects cloud spending to increase to nearly $500 billion in 2023 from $229 billion in 2019.

Lately, Microsoft is integrating Azure’s cloud capabilities into its gaming segment. The move should help the company expand beyond offering exclusive gaming content on Xbox consoles. Microsoft has partnered with Nvidia (NVDA). Notably, Nvidia’s ray tracing technology could enhance the experience for Microsoft’s “Minecraft” video games. We think that the partnership will give Microsoft a competitive edge over its peers in the cloud and gaming sectors.

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Microsoft’s Azure competes with Amazon (AMZN)—the industry leader with its cloud service AWS (Amazon Web Service). In the second quarter, AWS revenues grew 37.4% YoY. Notably, AWS held a cloud market share of around 33% at the end of the second quarter, according to Synergy Research Group. AWS is followed by Microsoft with a 16% cloud share, and Google (GOOG), IBM (IBM), and Alibaba (BABA). Read Could Microsoft Azure Be the Next Windows? to learn more.

Strength in Microsoft Windows

We expect Microsoft Windows’ revenues to continue to be strong in the first quarter amid healthy demand for PCs (personal computers). According to a report by Canalys, the worldwide PC market grew 4.7% in the third quarter—the highest growth in the PC market since the first quarter of 2012.

Amid higher demand, Microsoft is also gearing up with its line of PCs. Recently, Microsoft unveiled its new Surface Pro X and updates for its Laptop 3 and Surface Pro 7 lines. We expect the company to position itself as a leading PC maker.

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Attractive share buybacks and dividend

Last month, Microsoft announced a new share buyback program and a dividend hike for its shareholders. The company increased the dividend by 10.9% to $0.51 per share. Also, the company added $40 billion to its buyback authorization.

We expect the company to continue its strategy of buying back shares in the first quarter. Share buybacks would lower the company’s share count and boost its earnings.

Why analysts love the stock

A lot of analysts have upgraded the stock ahead of its first-quarter earnings. Recently, Jefferies raised the rating on Microsoft stock to “buy” from “hold.” A Jefferies analyst thinks that the company “is a large diversified business with excellent visibility.” Last month, an Evercore analyst raised its target price on the stock.

As a result, bullish analysts gave Microsoft a 12-month target price of $157.39. The target price is at a 14.5% premium to the current price at $137.41 on October 18. Among the 34 analysts covering Microsoft stock, 32 recommended a “buy,” while two recommended a “hold.” None of the analysts have a “sell” rating on the stock.

Microsoft stock fell 1.63% on October 18 and closed at $137.41. At the closing price, the company’s market cap was about $1.06 trillion. Currently, Apple (AAPL) is the most valuable public company. As of October 18, Apple’s market cap was $1.07 trillion.

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