The indispensable tech name still doubling revenues and profits

David Thornton

Livewire Markets

It has been described by some as the world's best company but no big tech company has been immune from the savage selloff of growth companies this year. And even when your earnings are miles ahead of the competition, sometimes that isn't enough to save your share price.

Despite beating on the top and bottom lines, Microsoft (NASDAQ: MSFT) fell short on forward guidance. Microsoft now expects $52.35 billion to $53.35 billion in revenue for the fiscal second quarter, shy of consensus expectations of $56.05 billion. And because of that, the stock traded nearly 7% lower in after-hours trading at one point.

“Continued customer commitment to our cloud platform and strong sales execution drove better than expected commercial bookings growth of 28% and Microsoft Cloud revenue of $23.4 billion, up 32% year over year,” said Amy Hood, executive vice president and chief financial officer of Microsoft. 

So, in true COVID-19 FOMO style, the question must be asked - is the post-earnings selloff providing an opportunity to buy the dip?

Dan Ives, an analyst at Wedbush, believes so - assigning the stock a price target of $290.  

“We would be buyers on weakness this morning and believe this is a resetting of expectations and not the start of multi-quarter painful guidance reduction cycle,” he says. 

“The stock has already reflected a clear slowdown in cloud and a disaster PC market over the last few months. Now the Street needs to discern is this just the first shoe to drop for MSFT or a rip the band-aid off moment.”

For a local viewpoint, I sat down with Thomas Rice from Perpetual to find out why he thinks Microsoft's value is disconnected from its price. 

Thomas Rice, Perpetual

Note: This interview was conducted Wednesday October 26th 2022. The company is a top holding in the Perpetual Global Innovation Share Fund.

Managed Fund
Perpetual Global Innovation Share Fund
Global Shares

Microsoft (NASDAQ: MSFT) FY22 Q3 key results

  • Earnings of US$2.35 per share, vs. US$2.30 per share as expected by analysts, according to Refinitiv.
  • Revenue of US$50.12 billion vs. US$49.61 billion as expected by analysts, according to Refinitiv.
  • Net income of US$17.56 billion, down 14%

In one sentence, what was the key takeaway from this result?

The key takeaway from Microsoft's result is that corporates are becoming more focused on the efficiency of their overall IT spending.

What was the market’s reaction to this result? In your view, was it an overreaction, an under reaction or appropriate?

The market had a negative reaction to the result, with the stock trading down 6.7% in the after-hours session.

The reason for this is that their key cloud business unit, Azure, is slowing down more than predicted. Azure only grew 42% in the past quarter instead of the 43% people expected it to, and guidance for next quarter's growth came in at 37%. This is the first time that Azure has ever grown under 40%.

It's not surprising investors would become a little more cautious on the stock in the short-term, but I'd say the slowdown in Azure reflects the weakening macroeconomic environment where corporates are tightening their spending, rather than a reflection on the long-term opportunity from cloud or their competitive positioning. If anything, Azure is likely still the fastest growing major cloud provider.

Were there any major surprises in this result that you think investors should be aware of?

The slowdown in cloud was the main surprise - not that it was slowing down, but that it was a little worse than expected.

Within the results, Microsoft's progress in developing machine learning products was the most interesting. Tasks that were once done by office workers are now being automated rapidly, and we believe this is only the beginning.

A product like GitHub CoPilot uses machine learning to suggest code as you write, similar to how autocomplete works on your phone but for complete block of code. I have used it before, and it is amazing how well it actually works.

We'll see machine learning being added to more products, not only new but existing ones as well. And this increase is starting to show up in Azure's revenue numbers, with this marking the 4th quarter in a row where machine learning revenue increased by over 100%.

Would you buy, hold or sell MSFT on the back of these results?

Microsoft is one of our existing holdings and we are very positive on the company’s ability to keep growing and gaining market share in one of the world’s biggest markets.

We will likely continue to hold through this shorter-term turbulence, and possibly look to add should its price become even more disconnected from its value.

It's still a business growing revenue and operating income by double digits, its competitive position has never been stronger, and it remains a key partner for many enterprises.

What’s your outlook on MSFT and its sector over FY23? Are there any risks to this company and its sector that investors should be aware of?

Although Microsoft will still feel the repercussions of a down economy, their product is essential for customers, making it a necessary spend. This should make them more resilient than other technology stocks during a recession and allow them to continue to grow strongly when the economy improves.

We don't know how FY23 will unfold, but we do think Microsoft will likely do better than peers in most scenarios. The major risks are mainly macroeconomic, with FX already being a major headwind.

But then beyond FY23, cloud represents a significant long-term opportunity, Microsoft occupies an incredibly strong competitive position, and the number of problems they can help solve with software, things like collaboration with Teams or things like robotic process automation, is only increasing over time.

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David Thornton
Content Editor
Livewire Markets

David is a content editor at Livewire Markets. He currently hosts The Rules of Investing, a half hour podcast where he sits down with leading experts across equities, fixed income and macro.

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