For Microsoft, these are the best of times and the worst of times. That’s the conundrum investors face with the software giant’s March-quarter-earnings report.
Microsoft is set to report third-quarter fiscal 2023 results on Apr 25.
Street consensus estimates call for March quarter sales of $51.1 billion, up 4% from a year ago, with profits of $2.26 a share. Microsoft provides sales guidance for each of its three business segments. The company sees growth of 17% to 19% for its “intelligent cloud” segment, which includes Azure. For the “productivity and business processes” segment, Microsoft projects 11% to 13% growth; for “more personal computing,” down 15% to 18%.
Microsoft has had a optimistic year so far, up more than 20% year to date, while falling over 28% last year. The upcoming earnings will become a new catalyst for this tech giant's stock.
Previous quarter review
Microsoft issued a disappointing revenue forecast for the current quarter in its earnings call, causing a reverse in the stock price after the shares initially rallied on better-than-expected earnings for the December quarter.
The technology company saw a dropoff in business at the end of 2022 in core Windows and Office areas, CEO Satya Nadella told analysts on a conference call.
Here's how the company did:
Earnings: $2.32 per share, adjusted, vs. $2.29 per share as expected by analysts, according to Refinitiv.
Revenue: $52.75 billion, vs. $52.94 billion as expected by analysts, according to Refinitiv.
Microsoft's Azure cloud growth slowed to 31%, barely beating analysts' projections.
Management called for $50.5 billion to $51.5 billion in revenue for the next quarter, while analysts expected over $52 billion, with Azure growth slowing further.
The software maker took a $1.2 billion charge in the quarter in connection with its decision to eliminate 10,000 employees, revise its hardware lineup and consolidate leases.
What to expect on Q3
Microsoft's fiscal 3Q results could indicate a further slowdown in PCs, along with weak infrastructure software results that could affect both Azure and on-premise sales. Azure could post 31% constant-currency sales growth in 3Q, down 700 bps sequentially, with 4Q at 2-3% below consensus of 28%, reflecting a more pronounced slowdown. Constant-currency server sales expansion may decline in the low-single digits in 3Q, the first drop in 10 quarters, after a 2% increase in 2Q.
Microsoft has been aggressive in marketing AI enhancements over the past two months, but it is not expected these features to create a sizable contribution to near-term sales growth. However, it is expected management to indicate increased interest from advertisers and other vendors in its enhanced search capabilities.
PC Shipment Decline is Likely to Hurt Top Line
Revenues from Windows are likely to have been driven by steady traction seen in Windows Commercial products and cloud services growth amid weak personal computer (PC) demand.
The decline in PC shipments aggravated in the first quarter of 2023, according to the latest data compiled by market research firm, International Data Corporation (“IDC”). The first quarter marked the fifth consecutive quarter of PC sales decline, following two successive years of strong year-over-year growth, driven by pandemic-led increased demand for remote-working and online-learning tools.
Among big PC vendors, Dell Technologies, Apple and Lenovo registered a decrease in shipments. Apple registered the highest fall of 40.5% to 4.1 million units, followed by Dell Technologies’ 31% to 9.5 million PCs.
For more personal computing, the company projects revenues between $11.9 billion and $12.3 billion, pressured by a sharp decline in the PC market. The company sees Windows OEM revenues to decline in the mid-to-high 30s in line with the PC market.
Microsoft Azure’s growth rate
Investors will be watching closely for Microsoft Azure’s growth rate. It’s dropped in recent quarters, and some analysts are concerned that the current projections for the next year are too optimistic.
For Intelligent Cloud, Microsoft anticipates revenues in constant currency to increase between 17% and 19% to a range of $21.7-$22 billion. Microsoft warned that revenue growth from Azure, the cloud computing platform that has become one of the main engines of its business, would slow by 4 or 5 percentage points sequentially in the fiscal third quarter, leaving aside the effect of currency movements.
Despite the slowdown in the overall growth of the Cloud market, MSFT should continue to expand its share at the expense of competitors. Microsoft has been aggressive in marketing AI enhancements over the past two months, but it is not expected these features to create a sizable contribution to near-term sales growth.
AI leader
Thanks to the company’s strong relationship with the ChatGPT creator OpenAI, Microsoft has become the perceived early leader in generative artificial-intelligence software. The company has rolled out AI-enhanced versions of many of its most important software platforms, including not just the Bing search engine, but also Office, Dynamics (software for running businesses), and GitHub (software for writing code).
After placing an early bet on OpenAI, the creator of ChatGPT, Microsoft has another secret weapon in its arsenal: its own artificial intelligence chip for powering the large-language models responsible for understanding and generating humanlike language.
It should be noted that converting AI investment into income takes time.
Analyst opinions
Wall Street analysts have lately been boosting their price targets for Microsoft shares, while at the same time expressing some concern about the near-term outlook.
Oppenheimer analyst Timothy Horan boosted his target to $310, from $280, while keeping his Outperform rating on the stock, specifically to reflect his view that that the debut of new AI-powered versions of its software should eventually drive 3 to 5 percentage points of incremental revenue growth starting in the June 2025 fiscal year. But he cautions that near-term growth will be tempered by “the wobbly economy and the spreading banking sector rot.”
Stifel analyst Brad Reback raised his target to $310 from $290, while keeping his Buy rating. Reback writes that the March-quarter results are likely to be “somewhat of a mixed bag”—he trimmed his estimates for the quarter to reflect both the soft PC market and “per-seat headwinds” as some enterprise IT buyers trim budgets.
Reback contends the “biggest wild card” is when the Azure growth rate stabilizes. He looks for the growth rate to bottom out in the mid-20% range about the middle of calendar 2023, but notes that further economic deterioration could push the bottom out to next year. “[W]hile Microsoft cannot outrun a global slowdown, we expect management to remain unwavering in its commitment to operational excellence and, even in the face of aggressive Cloud and AI investments, believe that revenue growth should meaningfully outpace [operating expense] increases in FY24,” he writes.
Wedbush analyst Dan Ives boosted his target price to $315 from $290, asserting that the company is seeing good deal flow for Azure, and that the company should be able to post Azure growth in the low 30% range for the quarter. He contends that less than 50% of enterprise computing workloads have shifted to the cloud—leaving plenty of room for growth. And Ives thinks AI will be “the next leg of the growth stool” for Microsoft.
BMO Capital Markets analyst Keith Bachman inched up his target price on Microsoft stock to $310 from $305, asserting that generative AI should boost the growth of the company’s search business. But he keeps a Market Perform rating on the stock “based on valuation.”
