Microsoft Stock (NASDAQ:MSFT)
The tech sector is gradually adopting the features of conventional industries that are highly tied to the macro picture. Microsoft Corporation (NASDAQ:MSFT) mirrored the rest of the IT sector’s transformation, and despite its position at the forefront of the sector, revenue growth began to decelerate even in the cloud segment. Yet, the corporation is beginning to build an early moat against the competition by incorporating AI into all products and services. I believe MSFT has a decent chance of developing critical competencies in AI-powered cloud products and benefiting from the digital transition environment. Notwithstanding the fact that the valuation suggests a limited upside from current levels, I am optimistic about Microsoft stock‘s future.
Overview and Prospects
In 2022, we will see a large increase in IT investment for digital business activities, particularly in the area of data center systems. The focus of global IT spending is projected to shift to software, which will support the expansion of cloud solutions. Notwithstanding the global economic downturn, which is causing enterprise IT budget cuts, I believe the cloud computing market will stay resilient due to the 9.3% growth in worldwide software consumption.
In Q2’23, the cloud segment remained the primary driver of Microsoft’s revenue growth. Overall revenue increased by 2% year on year to $52.8 billion, owing to the robust success of Intelligent Cloud and the contribution of Productivity & Business Processes. Microsoft Cloud sales reached $27.1 billion during the quarter, and despite slowing growth, revenue from the Azure platform and other cloud services increased by 31% year on year (up 38% year on year in constant currency).
In Q3’23, the business forecasts Azure growth to be less than 30% year on year. In light of encouraging cloud transition patterns and a favorable software expenditure prognosis, Microsoft may be optimistic about the cloud business’s growth prospects, in my opinion. Furthermore, as of the end of the second quarter, the obligations under concluded contracts totaled $189 billion, a 28.6% increase over the previous year.
On the negative side, the Personal Computing division appears to be the most troubled, with revenue down 18.8% year on year in Q2, resulting in an 8.3% year-on-year fall in EBIT and a 433 bps decline in overall operational profitability. The future is similar, with Device expenditures expected to fall by 5.1% in 2023 because of extended device renewal cycles, adding to the 10.6% drop in 2022.
During the most recent earnings call, the company stated that its information security unit generated more than $20 billion in revenue during the previous year. With the increased use of the cloud and remote work settings, there will be an increased requirement to secure the user’s data and apps. Microsoft has had good results in this market, despite having to compete with specialized cyber suppliers. Because of continuous digital transition trends and growing awareness of digital security, I anticipate that the cybersecurity business will surpass IT spending in terms of growth. Also, the advancement of cybersecurity may limit hacker activities, which are harming Windows and other newly licensed products, particularly in the consumer market.
Moving forward, AI technologies will be among the primary areas of investment for tech companies, shaping the future competitive landscape. Despite the fact that AI is still in its early stages, Microsoft has begun to build a moat from afar with a $10 billion investment in OpenAI. ChatGPT, which has already gained traction, will improve Azure platform cloud services and the Bing search engine against the backdrop of Google (NASDAQ:GOOGL).
Although the cloud business may assure Microsoft’s future success, the corporation is still looking to expand its addressable market. It’s becoming evident that the Activision Blizzard (NASDAQ:ATVI) acquisition may not go through due to regulatory pressure. At the same time, Microsoft remains optimistic about closing the $69 billion transaction by the end of 2023. Microsoft, on the other hand, has nothing to lose. Furthermore, Netflix is said to be the next item on the company’s shopping list. Based on the management’s aspirations, it may be assumed that the company is aggressively attempting to expand its consumer offerings.
According to Gartner, 25% of individuals will spend at least one hour every day in the metaverse for work, shopping, and other purposes by 2026. Microsoft is also interested in developing a metaverse experience. The business introduced the Mesh platform in 2021, which might be integrated into various Microsoft products (Teams, Azure, and Dynamics 365) in the future. Furthermore, the Azure platform’s capabilities enable cooperation with digital twins, which many companies, particularly manufacturers, currently employ.
Moving forward, in order to protect profit margins and respond to inflationary pressures, Microsoft has announced a 10,000-person layoff. This metric should help to promote operating profitability. Yet, given that the gross margin remained unchanged at 67%, Microsoft is doing fairly well. Add to it the negative impact of currency fluctuations, which will weaken the currency in the future.
Microsoft expects the Intelligent Cloud sector to outperform in terms of growth in the fiscal year 23 third quarter, with sales of $21.7-22.0 billion (up 14-16% year on year). Revenue in the Productivity & Business Processes area is expected to expand significantly by 7-9% year on year, reaching $16.9-17.2 billion. Revenue in the Personal Computing segment is expected to be in the range of $11.9-12.3 billion, contributing negatively to performance with a 16% to 18% YoY reduction.
Analyst projections of $233.2 billion in revenue and $10.8 in earnings per share for FY2024 imply forward sales and earnings multiples of 8.5x and 25.3x, respectively. Going back five years, MSFT has traded closer to 9x EV/Sales and 30x P/E multiples. Based on this, I anticipate a moderate upside potential of 9.8% to the target price of $298 per share from the present levels.
In terms of capital return to shareholders, Microsoft returned $9.7 billion to shareholders through share repurchases and dividends during the quarter. As the new fiscal year began with greater quarterly dividends of $0.68 per share, the buyback was cut from $6.2 billion to $4.6 billion per quarter to reflect the decline in FCF. Yet, the corporation remains steadfastly committed to shareholder returns and stock performance.
Although software spending is expected to climb significantly in 2023, macroeconomic uncertainties may further constrain IT budgets and necessitate continual spending efficiency. This might limit Microsoft’s commercial and consumer business, as well as reduce demand for Azure and Office solutions.
Despite the fact that the tech sector was thought to be defensive to some extent, with consistent earnings, particularly following the Covid-induced economic recession, even the leaders have recently faced a growth slowdown. As a result of the upcoming reduction of 10,000 personnel, Microsoft has been interested in optimizing operating costs. I am positive about Microsoft stock because the firm is well positioned to capitalize on growth prospects with the anticipated AI-infused features in its products and grab valuable market share away from the existing leaders in cloud and search engine solutions.
Featured Image: Unsplash @ Matthew Manuel