Current Price: $328 Price Target: $375 (from $340)
Position Size: 8.3% TTM Performance: 62%
Key takeaways:
- Broad beat with 22% YoY revenue growth and +27% op. income growth.
- Azure continues to be key growth driver – continuing to take share in the public cloud with revenue growth of +51% YoY (+45% constant currency), similar to last quarter.
- PC Market better than expected despite supply chain headwinds – Windows OEM numbers blew away their guidance and guidance for December quarter was also way above what investors were expecting. “The future of how we work, connect, and play, one thing is clear: the PC will be more critical than ever. There has been a structural shift in PC demand emerging from this pandemic.”
- CEO, Satya Nadella said…“Digital technology is a deflationary force in an inflationary economy. Businesses – small and large – can improve productivity and the affordability of their products and services by building tech intensity.”
Additional Highlights:
- More quotes…
- On labor market: “We are experiencing a great reshuffle across the global labor market as people are rethinking not only where and how they work, but why, and as more people change jobs than ever before.” Hires on LinkedIn were +160% YoY.
- “Cybersecurity is the number one threat facing businesses today.”
- “will need to watch the advertising market through the quarter because obviously their willingness to spend is entirely connected to their supply as well.”
- On inflation: “in an inflationary environment, the first place any business should go to is, how to really ensure that they’re able to get productivity gains and, even dealing with constraints for example, if you have supply chain constraints one of the things you want to do is run your factories at the efficient frontier. That means things like digital twins, simulation are the ones where you are going to make sure that every production run has the least amount of wastage. So I think any which way you look, whether it’s in the knowledge worker, first-line worker, whether it’s actually digital twins and simulation, all of those things are going to be the best way for any company to deal with inflationary pressures, so that they can in fact have the best productivity and thereby the best ability to be able to meet aggregate demand out there. So that’s why we are very, very excited about sort of making sure our software products are available to our business customers all around to be able to manage through this inflationary environment.”
- Commercial cloud, which aggregates Azure, Office 365, the commercial portion of LinkedIn and Dynamics accelerated by 500bps sequentially to +36% YoY cc growth reaching >$80bn run rate (Azure is high $30B’s run rate, so approaching half). They continue to see significant growth in the number of $10 million plus Azure and Microsoft 365 contracts. Cloud gross margins increased 400bps (excluding the impact of an accounting change).
- While Microsoft benefited from accelerated digital transformation from the pandemic, they are well positioned to capitalize on a number of long-term secular trends that will continue to drive mid-to-high teens earnings growth. Secular drivers include public cloud and SaaS adoption, continued digital transformation, AI/ML, BI/analytics, and DevOps. As organizations become increasingly digital, MSFT’s products are evolving from being primarily productivity tools to being more strategic tools. This suggests an improving value proposition to customers, which is key to the durability of their LT growth and profitability.
- Productivity and Business Processes ($15B, +22% YoY):
- LinkedIn – revenue increased 42% (up 39% in constant currency) driven by Marketing Solutions growth of 61%. LinkedIn now has nearly 800 million members. And now has 15K enterprise customer for LinkedIn Learning and seeing high demand for upskilling/reskilling employees.
- Office 365 Commercial (rev +23%)- driven by installed base expansion as well as higher ARPU.
- Dynamics 365 (rev +48%) – Power Platform (low-code, no-code tools, robotic process automation, virtual agents and business intelligence) now has nearly 20 million monthly active users up 76% YoY.
- Intelligent Cloud ($17B, +31% YoY):
- Server products and cloud services revenue increased 35% with Azure revenue growth of 50% (48% cc). Exceeded their expectations across consumption and per user Azure businesses as well as their on-premises server products business.
- An increasing mix of large, long-term Azure contracts can drive quarterly volatility in the growth rates. Leader in hybrid cloud and have more datacenter regions than any other provider – and continuing to add data center regions, including new regions in China, Indonesia, Malaysia, as well as the US.
- More Personal Computing ($13.3B +12% YoY):
- Windows OEM revenue increased 10%
- Surface was weak (down 17%) as constraints in the supply chain continue
- Gaming revenue increased 11% (7% in constant currency). Xbox hardware revenue grew a 166%, driven by demand for new consoles and better than expected supply. Xbox and content and services revenue increased 2% against a high prior year comparable.
- Search advertising revenue increased +40% YoY as companies pick up spending on digital advertising
- Valuation:
- Recurring revenue is ~60% of total, underpins most of their valuation and is resilient and poised for additional growth. Particularly Azure, Office 365 and Dynamics 365. Stock is trading at <3% forward FCF yield; a premium to the S&P, but supported by their high moat and solid secular growth drivers.
Sarah Kanwal
Equity Analyst, Director
Direct: 617.226.0022
Fax: 617.523.8118
Crestwood Advisors
One Liberty Square, Suite 500
Boston, MA 02109