Current Price: $108 Price Target: $120
Position size: 5% TTM Performance: 28%
Microsoft reported a very strong quarter, easily beating on top and bottom line. Revenue was $29B (+18 YoY) vs $27.9B estimate. And EPS was $1.14 (+33% constant currency), well ahead of $0.96 estimate. Guidance was also better than expected. 2Q19 guided to revenue of +10-13%. Hybrid cloud momentum continues, cloud margins are improving and numbers getting raised since they reported. They were very positive about the overall environment. On the call management said they continue “to benefit from favorable macroeconomic and spending trends.”
Key Takeaways:
· Solid double digit growth across all 3 segments:
o Productivity and business processes grew 19%. Guided in-line with the street.
o Intelligent Cloud grew 24%. Fastest growing segment with lowest margins, but margins are expanding (+400bps YoY). Revenue guidance higher than the street.
o More Personal Computing grew 15%. Revenue guidance higher than the street. Gaming revenue increase 44%. Xbox Live monthly active users grew 8% to 57 million. Surface revenue grew 14%. Seeing continued Windows 10 traction with enterprises.
· Commercial Cloud revenue (consisting of Office 365 Commercial, Azure, Dynamics Online, and LinkedIn Commercial, so pulls from the first 2 segments) was $8.5B, +47% YoY.
o Within Commercial Cloud, Azure grew 76%. That suggests annualized revenue of about $11B.
o Azure gross margins continue to improve.
· Management expects a neutral YoY FX environment for revenue and a ~100bps headwind to COGS and operating expenses in F2Q19.
· GitHub acquisition will close by end of this year and will be included in the Intelligent Cloud segment.
· Nadella continues to try to differentiate them as the vendor enterprises can trust. In advocating for their cloud solution, he said “no customer wants to be dependent on a provider that sells them technology on one end and competes with them on the other.” A clear attempt to contract them to AWS.
Valuation:
· FCF in the quarter was $10B. Returned $6.1B to shareholders ($3.5B in dividends and $2.6B in share repurchases).
· Trading at >4% FCF yield – reasonable for a company with double digit top line growth, high ROIC and a high and improving FCF margins.
· They easily cover their 1.7% dividend, which they have been consistently growing.
· Strong balance sheet with about $136B in gross cash, and about $60B in net cash.
· Price target based on ~30% FCF margins and mid-to-high single digit top line growth.
Investment Thesis:
· 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.
· Return of Capital: High FCF generation and returning significant capital to shareholders via dividends and share repurchases.
$MSFT.US
[tag MSFT]
Sarah Kanwal
Equity Analyst, Director
Direct: 617.226.0022
Fax: 617.523.8118
Crestwood Advisors
One Liberty Square, Suite 500
Boston, MA 02109