MSFT reported FY Q1 2018 results that beat expectations. Revenue surpassed estimates by the highest percentage in two years and EPS was 10% above consensus. Growth was driven by commercial cloud services as Microsoft’s hybrid cloud is now used by nearly every Fortune 500 company. LinkedIn has performed better than internal expectations, and global performance was better than expected in large markets. MSFT continues to mobilize to pursue customer solutions across its core areas.
Current Price: $84 Price Target: $69
Position Size: 4.4% TTM Performance: +43%
1.) Microsoft had a strong start to the fiscal year with double digit top and bottom line growth as a result of consistent execution and ongoing investments
a. Revenue was $24.5 billion for the quarter, up 11% cc with better than expected performance across all segments
b. Operating income increased 15% and EPS was up 17% at $0.84
c. MSFT is ahead of its original financial commitment for LinkedIn, which contributed 5 points to revenue and margin growth with 4 point drag on operating income; They expect LinkedIn to be accretive to EPS this fiscal year
d. Commercial cloud business had another quarter of robust growth, as revenue increased 56% yoy and gross margin increased to 57%
e. Company gross margin was up 2 points to 66% due to higher-margin products and improving cloud margins
2.) MSFT continues to partner deeply with customers so that new technologies and innovations can help them digitally transform and thrive. Here are some of the recent advancements across core customer solution areas.
a. Product Integration – bringing together 365, Windows 10 and Enterprise Mobility + Security as an integrated platform for companies of all sizes. They launched new AI interfaces in 365 and enabled on demand cloud sharing and co-authoring experiences through Windows 10.
b. Windows Mixed Reality – utilizes integrated products to blend physical and digital worlds across devices. MSFT has worked with Ford to use mixed reality to blend holograms digitally with models and physical production vehicles.
c. LinkedIn – ahead of internal expectation with increased levels of engagement. LinkedIn is on pace to surpass 21 billion sessions this calendar year with its fourth consecutive quarter of sessions growth.
d. Cloud Computing – hybrid cloud content has been extremely successful. Azure provides a consistency across the public and private cloud that can be used by large and small businesses. Azure is the only public cloud with an AI based security system that enables encryption of in-use data.
e. Gaming – taking advantage of the fast growing trend toward mobile gaming. They are a few days away from launching Xbox One X.
3.) MSFT now trades at a forward P/E of 24.7x with a real yield of approximately 4.5%; not unreasonable to expect some multiple compression over time
a. MSFT ended the quarter with net cash of $53 billion
b. Stock remains supported by real yield of ~ 4.5% (2% div yield and 2.5% buyback)
The Thesis on MSFT
• Industry Leader: Global monopoly in software that has a fast growing and underappreciated Cloud business
• Product cycle tailwinds: Windows 10 and transition to Cloud (subscription revenues)
• Huge improvements in operational efficiency in recent quarters providing a significant boost to margins which should continue to amplify bottom line growth
• Strong balance sheet ($100+Bn gross cash) allows company to be opportunistic in current environment/
• Return of Capital: High FCF generation and returning significant capital to shareholders via dividends (2.5% yld) and share repurchases (2-3% run rate)