Microsoft Inc (MSFT)
FY24 Q2 Results
We have written on Microsoft on a number of occasions. These can be found here and here. We will look at their latest quarterly results reported yesterday.
On 30 January, Microsoft (MSFT) Q2 Results beat expectations on the top and bottom line.
Summary Results
Microsoft reported adjusted EPS of $2.93 on revenue of $62 billion, beating expectations of adjusted EPS of $2.78 on revenue of $61.1 billion. It beat revenue estimates by 1.8% and guidance by 1.5%.
Revenue was a record $62.0 billion, an increase of 16% . These numbers include Activision Blizzard, taken over by Microsoft, for the first time. If we ignore this, Microsoft’s organic growth was 13.5%.
Operating income was $27.0 billion and increased 33%.
Net income was $21.9 billion and increased 33%,
Diluted EPS was $2.93 and increased 33%.
Microsoft completed the acquisition of Activision Blizzard, Inc. (“Activision”) on October 13, 2023.
Numbers have to be adjusted for Activision Blizzrd to get accurate comparability. However, even adjusting for this, these are good quarterly numbers for Microsoft again.
Source: The Stock Market Nerd
The key Azure Cloud business grew at 30%, the fastest rate of growth in three quarters as AI products and services boosted this business segment.
Source: The Stock Market Nerd
Margins fell back from the Q1 2024 levels but are 2% -3% points higher than the same quarter in 2022. EBIT margin would have been 44.3%, ex-Activision, compared with the 43.6% reported. Therefore, Activision initially, is slightly dilutive for margins.
Microsoft: The three Business Segments
The graphic above shows the business segments that Microsoft uses to report its results.
In 2018/2019, the financial breakdown between divisions was very easy to remember.
The quarterly run rate for total revenue was US$30bn (~ US$10bn in each segment) and quarterly operating profit run rate was US$ 9bn.
Since then, things have changed as the Intelligent Cloud segment has grown much more rapidly while More Personal Computing growth was stagnating. However, in this quarter, it has been boosted by the inclusion of the Activision numbers.
In the most recent quarter, the revenue for each segment was as follows:
Intelligent Cloud- US$ 25.8bn (+20%)
Productivity and Business Processes- US$ 19.3bn (+13%)
More Personal Computing- US$ 16.9bn (+19%).
The Intelligent Cloud business, which includes its Azure service, was the strongest segment and came in at $25.8 billion versus expectations of $25.3 billion.
AI services contributed an amazing 6 percentage points of growth to Azure revenue, increasing from 3 percentage points last quarter.
Productivity and Business Processes revenue was hit $19.25 billion, just ahead of estimates of $19.03 billion.
More Personal Computing, which includes sales of its Windows software and Xbox gaming division, generated $16.9 billion. Growth was boosted by the inclusion of Activision blizzard. Without it, the growth of this segment would have been 13.9%.
Conference Call Highlights
The emphasis of the Conference Call was on Generative AI Services and Products.
"We’ve moved from talking about AI to applying AI at scale,"
"By infusing AI across every layer of our tech stack, we’re winning new customers and helping drive new benefits and productivity gains across every sector.”
Microsoft may not have the most technologically advanced products, but its core strength is its Enterprise Sales and Distribution force. This update again demonstrated the power of their salesforce.
Commercial bookings and demand were better than expected thanks to long term Azure contract strength. Commercial bookings rose by 17%.
Current remaining performance obligations (cRPO), which is a great indicator of the strength of future demand, rose 17% to a record $222 billion.
Microsoft 365 now has 78. million consumer subscriptions. These rose 15.8%.
Commercial 365 enterprise seats rose 9% to cross 400 million (!)
The Coud business not only grew strongly but remains very profitable. Cloud Gross Margin was 72%,
AI Approach
Microsoft had an early advantage in AI thanks to its investment in ChatGPT developer OpenAI. It has used this to move fast to become the dominant player in the emerging AI business. Microsoft has invested heavily in its AI efforts and these permeate nearly every part of its business.
So far, it has monetized its AI efforts.
via generative AI cloud services,
its Copilot for Microsoft 365 productivity platform, and
its Copilot Pro for consumers.
Generative AI added a full 6 percentage points to Azure’s growth for the quarter. Azure AI customers rose by roughly 50%. This shows Gen AI is already making a large financial impact. 50% of the Fortune 500 companies use Azure AI already.
Copilot was first integrated into Microsoft GitHub and it had an immediate impact. GitHub Copilot subscribers rose 30% Q/Q to reach 1.3 million.
Now Copilot is quickly making its way to the rest of the product suite. In January, the company opened up its Copilot for Microsoft 365 to all businesses. It had been restricted to customers with 300+ employees. Clients pay $30 per user per month for access to the software.
Copilot Pro for consumers, meanwhile, costs $20 per month per user, and is meant for consumer customers who want to take advantage of Copilot’s more advanced features.
Copilot is not a take it or leave it product. Copilot Studio allows customers to tailor and customize industry-specific needs to make the Copilot “work companion” even more relevant to their own productivity.
In the last three quarters, Microsoft and Amazon have noted a slowdown of migration of workloads to the Cloud as companies focused on optimising already migrated workloads. Yesterday, Satya Nadella said the “period of massive optimization of cloud workloads has ended.” This means the pace of growth of workloads to the Cloud is likely to increase again.
Summary
Microsoft has been a strong performer for many years.
The Cloud business has seen accelerated growth.
The company has moved very rapidly to develop and monetise AI products.
Both Cloud and generative AI are well set for high growth for the next five to ten years.
Conclusion
In May 2023 we said the following:
Microsoft has been our favourite large cap tech stock for the last three years.
It has performed very strongly in the last ten years and the most recent results continue the trend. The company looks set to grow in many established businesses especially the Cloud and is the best placed large tech company to benefit from developments in AI.
The current valuations (Forward P/E ratio of 29 times and Free Cash Flow Yield of 2.5%) do not indicate that the stock is cheap but given the profitable growth opportunities, we may add a little to our position. At the time Microsoft was trading at about US$ 300 a share.
On 23 December 2023, in a late review of the Q1 Results, we said the following:
The company has introduced AI in Azure AI and through Co-pilot in their desktop software and other platforms. The recent issues at OpenAI raises some questions given Microsoft close association with them. Whatever happens at OpenAI. Microsoft is well placed to be a leader in AI.
The stock has risen 53% this year and looks set to continue to make progress.
The company is likely to grow net profits at least 15% over the next two years with operating margins and Return on Equity of at least 43% and 40% respectively.
Given these prospects, the current forward price /earnings multiple of 30.7 times looks good value. At the time Microsoft was trading at about US$ 375 a share.
Microsoft is the largest holding in our portfolio. We added to the position after the results and continue to hold for the long run.
Today, after the Q2 results and Conference Call, we see little need to change the outlook.
The company remains likely to grow net profit at least 15% over the next two years with operating margins and Return on Equity of at least 43% and 40% respectively.
Given these prospects, the current forward price /earnings multiple of 33 times looks fair value.
Microsoft is our largest position, and we will continue to hold on,