Azure helps Microsoft drive strong results

Microsoft (“Wide Moat”) reported strong second quarter 2023 fiscal results, including revenue generally in line and modest EPS upside after taking into account restructuring charges of $1.17 billion.

The outlook for March, however, was once again below our estimates and consensus.

Azure continues to decelerate but is doing a little better than expected, while the macro environment is deteriorating a little more than expected.

Optimistic investors can point to good growth in Microsoft’s remaining performance obligation (RPO) and Azure, while pessimists can point to decelerating revenue growth.

We are lowering our wide-moat fair value estimate for Microsoft to $310 ($320) per share from $320 and continue to view the stock as attractive.

Unchanged long-term thesis

We believe the findings reinforce our long-term thesis centered around the proliferation of hybrid cloud and Azure environments as the company continues to use its on-premises dominance to allow customers to move to the cloud at their own pace.

We continue to focus our growth assumptions on Azure, migration from Office E5, and traction with the Power platform for long-term value creation.

That said, we continue to believe that results will remain modest in the coming quarters.

Revenue for the second quarter of the fiscal year (ending late December) increased 2% year-over-year, or 7% in constant currency, to $52.75 billion, from the midpoint forecast of $52.85 billion and the FactSet consensus of $52.97 billion.

Personal computing under pressure

Compared to the prior year period, Productivity and Business Process (PBP) sales were up 7%, “Intelligent Cloud” (IC) sales were up 16%, and “Computer personnel” (MPC) decreased by 19%.

Compared to expectations, PBP and IC performed well, while MPC underperformed.

Overall, renewals were generally flat while sales of standalone solutions were weaker.

We were pleased with the strong year-over-year growth (constant currency) of Azure (+38%) and Dynamics 365 (+29%), as both are key pillars of our growth estimates. long-term growth.

We expected continued weakness in certain product lines with advertising and consumer exposure, such as Bing, Windows, hardware and games.

Still, results were worse than expected in these areas, which was largely, but not entirely, due to weaker Surface performance.

Modest prospects

Geographically, the United States was slightly weaker than international.

Several of Microsoft’s key growth levers saw growth decelerate both sequentially and year-over-year.

Commercial bookings were up 4% year-over-year in constant currency, bringing the remaining performance obligation (RPO) to $189 billion.

The renewal base was more subdued this quarter, so we expected a significant deceleration in bookings growth, although the renewal and upsell rate remained strong.

We expect these trends to continue in the December quarter.

Azure Growth

Microsoft Cloud continued to grow thanks to Azure and grew 22% year-over-year in constant currency to $27.1 billion.

Importantly, Azure grew 38% year-over-year in constant currency, versus management’s forecast of 37% growth.

Microsoft continues to engage in successful campaigns to help customers optimize their workloads.

While these efforts will dampen Azure’s growth in the near term, management expects these campaigns to moderate, which should boost Azure usage and future revenue growth.

Falling margins

GAAP operating margin was 38.7% (40.9% after adjusting for the restructuring charge), compared to 43.0% last year, reflecting slower sales and continued investment in cloud, higher energy costs for data centers, charges related to the Nuance acquisition and LinkedIn.

We continue to see a path of margin expansion from already high levels over the next five years, which we believe will be driven by Azure’s gross margin rate improvement, even as the company suffers short-term pressure.

We find the third quarter forecast mild without surprise.

The March quarter outlook calls for revenue of $50.50 billion to $51.50 billion, or $51.00 billion in the mid-range, versus $52.51 billion for the Factset analyst consensus.

The forecast represents mid-term revenue growth of 3% year-over-year on an as-published basis and includes an expected currency headwind of 300 basis points.

Given the recent workforce reductions and the recent results of software peers, we expected the forecast to be lower than the stock exchange’s expectations.

We believe weak consumer-related revenue from Windows, Advertising and Gaming remains more under pressure than Enterprise Software in the near term.

As a result, we believe the bulk of the recently announced downsizing will focus on these areas, as well as expanded enterprise infrastructure and support.

We believe that Azure will be immune to these restructurings.

© Morningstar, 2023 – The information contained herein is for educational purposes and provided for informational purposes ONLY. It is not intended and should not be considered an invitation or encouragement to buy or sell the securities listed. Any comment is the opinion of its author and should not be considered a personalized recommendation. The information in this document should not be the sole source for making an investment decision. Be sure to contact a financial adviser or finance professional before making any investment decisions.


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