Microsoft (NASDAQ: MSFT) He has done it again. On July 22, the company delivered its sixth consecutive pace and the eleventh consecutive quarter of double-digit revenue growth.
A truck could be driven between year-over-year sales increases of almost 13% and pre-earnings expectations of just over 8%. The $ 1.46 EPS also landed long before the consensus, but there is a caveat: The number includes $ 450 million in one-time expenses incurred to close Microsoft’s physical locations in fiscal 4Q20. It is not clear whether the negative impact of these additional costs on the final result was taken into account in the estimates.
Despite solid headline numbers, stocks sold out in off-hours trading. I suspect the reason, but I also believe that the bearishness is not properly justified.
Credit: Headquarters contact information
Cloud excitement cuts both ways
Starting from the top, all major Microsoft segments experienced at least 8% non-currency revenue growth. Performance in personal computing generously exceeded my conservative expectations, lowering risk due to store closings, which could lead to weaknesses in Surface, PC accessories, and Xbox sales. In contrast, the division’s revenue increased 16% ex-FX.
The problem is that this coin has two sides. By performing beyond expectations, the PC business stole the thunder from what generally drives Microsoft’s biggest optimism: the cloud. Productivity and business processes, a segment that includes Office and cloud-based Dynamics 365, saw ex-FX revenue rise just 8% from 17% this time last year. Smart cloud revenue moved more by a solid 19% and beyond guidance, but this number fell below the growth rate of 21% last year and 29% the previous quarter.
Source: earnings slide
Even on the cloud issue, Azure revenue increased by 50% ex-currency (see chart below). However, the slowdown in the sequential growth rate in fiscal 4Q20 was the most pronounced since the end of the 2016 calendar. I expected this figure to approach 55% at the lower end of my estimated range, believing that the value of “two years of digital transformation in two months “would have been stronger since fiscal 3Q20.
Source: DM Martins Research, using data from company reports.
Lower down the profit and loss account, the gross margin seems to have had an impact on the productivity and business processes side due to the increased use of Office 365 Commercial and a greater combination of clouds. However, continued gains of scale on Azure and a larger PC revenue base helped offset some of the headwinds. Looking ahead, I think Microsoft’s operating margin outlook is positive, especially now that store closings and staff reorganization on LinkedIn should slow down operating expenses a bit.
Regarding the outlook for the next quarter, some of the same trends are expected to continue regarding cloud adoption, business strength, and challenges among small and medium customers. Personal computing should cool down a bit after a strong spring quarter, and segment revenue is projected to stabilize YOY.
According to my estimates, the guided growth in total revenues of less than 8% for fiscal 1Q21 did not reach the consensus, while the EPS derived from around $ 1.54 exceeded expectations by a little less than a penny. See the outlook chart below.
Source: DM Martins Research, using data from the earnings call
Bassism is an overreaction
In summary, Microsoft’s quarter was once again great and exceeded analyst consensus expectations. But the revenue mix may not have pleased operators much after hours, as front-line momentum wasn’t particularly cloud-driven this time around, at least not as much as it had in the recent past.
However, I think a little perspective is needed:
- YOY’s compositions were particularly difficult this time.
- The results appear to have been online or better than the guide.
- Achieving solid growth at the top and bottom line in today’s environment is rare and recommended.
- Microsoft emerged from an unusually strong quarter that benefited enormously from the economy of work, learning, and home gaming. It seems unfair to expect the same level of execution quarter after quarter.
Microsoft bears will probably mention the valuation once again as a reason to rescue stocks at current levels. To some extent, I understand these concerns. MSFT has been the best-performing Dow 30 stock so far in 2020, and the P / E advance is very close to multi-year highs of 35x.
Data by YCharts
However, I think this is a very difficult time to bet on low value names. Rather, I prefer to invest in companies that (1) are leaders in their industries, (2) run a strong recurring revenue business model, and (3) have deep pockets to weather a period of economic weakness. For these reasons, I’m still a Microsoft bull and I think any short-term weakness in the stock price represents a buying opportunity.
Beating the market for a mile
Microsoft has been a key contributor to the returns on my Storm Resistant Growth with all stocks since inception. But other mega-layer names have produced an even bigger slice of the portfolio’s profits, which have been better than the S&P 500 by a mile (see chart below, pink line).
To learn more about the storm-resistant growth approach to investing, I invite you to join our community. Click here and take advantage of the 14-day free trial today. After that, don’t forget to join the live chat so we can share some ideas.
Divulge: I am / we are long MSFT. I wrote this article myself and express my own opinions. I receive no compensation for it (other than Seeking Alpha). I have no business relationship with any company whose shares are mentioned in this article.
