Best stocks to invest in – What’s Next for Microsoft (MSFT) Stock?



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It has been about a month since the last earnings report for Microsoft (MSFT). Shares have added about 5% in the past month, edging out the S&P 500 in that time frame.

Will the recent positive trend continue leading up to their next earnings release, or is the stock due for a pullback? Before we dive into how investors and analysts have reacted as of late, let’s take a quick look at the most recent earnings report in order to get a better handle on the important drivers.

Recent Earnings

Microsoft  reported first-quarter fiscal 2017 earnings adjusted for Windows 10 deferrals and currency effect of $0.76 per share, which comfortably surpassed the Zacks Consensus Estimate of $0.68.

Revenues (adjusted for Windows 10 deferrals) of $22.33 billion dipped 1.4% sequentially but up 3.1% from the year-ago quarter (up 5% in constant currency or CC) and the Zacks Consensus Estimate of $21.54 billion.
 


Key Segment Details

Productivity & Business Processes includes the Office and Dynamics CRM businesses. Revenues slipped 4.5% sequentially but increased 5.6% (up 8% CC) on a year-over-year basis to $6.66 billion.

The Commercial business (products + Office 365 & related cloud services) revenue was up 5% from year-ago level (up 8% CC). Office 365 saw commercial seat growth of 40% from the year-ago quarter. This is an area of tremendous focus with reselling partners up to 90K in the last quarter as Microsoft goes all out to target the SMB segment.

Monthly active users of Office 365 commercial increased 40% year over year to more than 85 million. The company continues to win customers like eBay , Allergen, Exelon and Liberty Mutual Insurance. Office 365 commercial revenue soared 51% (up 54% in CC) from the year-ago quarter.

Dynamics and cloud services revenue jumped 11% (13% CC). Management noted that more than 70% of new Dynamics enterprise customers are choosing Dynamics online. The company mentioned HP Inc., which is replacing its CRM systems with Dynamics 365 to take advantage of the built-in intelligence feature.

Server product and cloud services revenue went up 11% year over year (up 13% in CC). Annuity revenue grew double-digits while transaction revenue declined.

The high point was Azure revenue, which soared 121% CC year over year, with Azure compute usage doubling. Microsoft is benefitting from its hybrid and hyperscale cloud, which spans multiple jurisdictions, making it ideal for multinational companies and banks that have operations all over the world and are required to be in compliance with laws of the countries in which they operate.

More Personal Computing comprises mainly the Windows, Gaming, Devices and Search businesses Revenues increased 4.5% sequentially but slipped 1.8% (1% CC) year over year to $9.29 billion.

Windows OEM Pro revenue increased 1% year over year (due to stabilization in the commercial PC market in the U.S.). Non Pro revenue declined 1% (on the back of a higher premium mix) from the year-ago quarter.

Windows commercial products and cloud services revenue was flat on a year-over-year basis (up 2% in CC) driven by annuity revenue.

Gaming revenue dropped 4% in CC; Xbox Live monthly active users were up 21% to 47 million. The company witnessed more than 20 billion hours of gameplay on Windows 10 PCs and tablets; more than 500% jump on a year-over-year basis.

Operating Results

Microsoft’s gross margin of 61.6% surged 40 basis points (bps) sequentially but down 300 bps from the year-ago quarter (gross profit dollars were almost flat sequentially but dropped 4.3% year over year).

The growth in gross profit dollars by segment was as follows: Productivity up 2% CC (increased mix of cloud offerings and investments in cloud were drivers), Intelligent Cloud 4% CC (again a result of increased mix of cloud offerings) and More Personal Computing 1% CC (search and Windows OEM were drivers neutralized by phones and Xbox).

Operating expenses (excluding Impairment, integration, and restructuring costs) of $7.38 billion were down 12.6% sequentially but were flat from the year-ago quarter. However, as percentage of revenues, operating expenses decreased 490 bps sequentially but increased 10 bps on a year-over-year basis. As a result, operating margin expanded 520 bps sequentially but contracted 290 bps on a year-over-year basis to 25.5%.

The operating margin by segment was as follows: Productivity 46.9% (up 380 bps sequentially but down 320 bps year over year); Intelligent Cloud 32.2% (down 40 bps sequentially and 830 bps year over year) and More Personal Computing 20.7% (up 990 bps sequentially and 460 bps year over year).

Guidance

Management said that FX would have a negative 1-point impact on revenue growth in second-quarter fiscal 2017 at both the total company and individual segment levels.

For the second quarter, Microsoft expects Productivity & Business Process revenues of $6.9–$7.1 billion, Intelligent Cloud revenues of $6.55–$6.75 billion and More Personal Computing revenue of around $11.2–$11.6    billion. This implies total revenues of between $21.05 billion and $21.25 billion.

Management said that 2017 operating expenses would be $31.1–$31.4 billion as investments in strategic growth opportunities continue. The non-GAAP tax rate is expected to be 20% (+/-2%) depending on the variability of factors such as mix of services revenue versus licensing revenue, the geographic mix of revenue and the timing of equity vests. A higher mix of cloud revenue is also anticipated to increase the tax rate.

 

How have estimates been moving since then?

Following the release and in the last month, investors have witnessed a downward trend for fresh estimates. There have been four revisions higher for the current quarter compared to seven lower in the past month. However, the full year figure is pretty bright, as the last month has seen 12 earnings estimate revisions higher compared to two lower. This is helping to long term EPS estimates in the right direction, as you can see in the chart below: 

 

 

VGM Scores

At this time, Microsoft’s stock has a strong Growth score of ‘A’, and an equally impressive grade on the momentum front. However, the stock was allocated a grade of ‘C’ on the value side, putting it in the middle 20% for this investment strategy. Overall though, the company has impressive fundamentals, and it has earned itself an ‘A’ grade for its VGM score. This puts the stock into rare company, as just 20% of securities we rank receive this grade. 

Outlook

Overall estimate activity has been mixed for MSFT stock. Yes, short term figures aren’t great, but ones that look a little further out are more impressive. Due to this back and forth nature, we have shares of MSFT at a Zacks Rank # 3 (hold), meaning we are expecting an in-line return from MSFT in the next few months, though investors focused on growth will likely appreciate the story in Microsoft stock more than most.

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