Most companies post dismal results and give unimpressive guidance, which compels analysts to immediately lower expectations. There isn’t much to appreciate about tech stocks. While the software sector undoubtedly benefited from pandemic tailwinds, it cannot avoid a reversion to the norm. As macro factors continue to drag down tech values, Microsoft Corporation (NASDAQ:MSFT) is one strong name that merits our attention. Let’s look at why Microsoft stock may perform better than expected in the coming months.
Going Back to the Bull Case for Microsoft Stock
The most straightforward argument for Microsoft stock is that cloud migration continues to be a sustainable growth story despite some moderating. Top-down, the public cloud market experienced >35% growth in the first half of 2012, even if the main three (AWS, Azure, and GCP) experienced some slowdowns due to more challenging comparisons. The top 3 cloud vendors now claim a combined annualized run rate of $147 billion, up 36% year over year in Q2 compared to Q1 and 41% overall.
While AWS had a 29% operating margin in the second quarter, Azure is anticipated to have a gross margin of over 60%. Despite not being profitable yet, Google Cloud Platform, the distant third vendor with less than 10% of the market, still experienced 36% year-over-year growth in Q2 compared to 44% in Q1. There is no doubt that cloud migration will continue to be a structural rather than cyclical issue, in contrast to some sections of the computer industry that were epidemic beneficiaries at one point.
The Future for Azure Is Promising
Microsoft’s total revenue growth in the June quarter (Q4FY22) was 12.5% year-over-year and +16% in constant currency, which was in line with expectations. Although the strong dollar had some FX effects, total RPO increased by 32% compared to 28% in the previous quarter. To reach $189 billion, commercial bookings climbed 37% CC. The unprecedented number of Azure sales between $100 million and $1 billion was emphasized by management. Azure sales grew by 46% (1% less than expected), while the September quarter is projected to see a growth of 43% (also 1% less than expected). Despite a modest easing amid macro worries about SMBs and increasingly consumer-focused industries, Azure’s growth is still solid due to lengthier booking commitments.
Despite his caution on the macroeconomic trends during the earnings call, CEO Nadella regarded cloud computing as a deflationary factor in a time of inflation as businesses are being compelled to get more done with fewer resources.
In addition to Azure, the need for cloud security is still on the rise as businesses strive to invest more to safeguard their data and digital processes. Microsoft revealed a 40% YoY increase in Security income, which is close to the $20 billion run-rate threshold.
The management has noted some consumer slowdown and has projected Azure growth to moderate from 46% CC to 43% CC for the September quarter (Q1FY23). Azure might end FY23 with a relatively solid 34% growth rate in Q4, assuming growth slows down by about 3 points per quarter in the future. Azure is in a fantastic position to benefit from a robust IaaS (Infrastructure as a Service) market that is predicted to grow another 30% to $156 billion in 2023, despite the strain the current macro narrative is placing on IT generally.
PC Softness Is a Problem, But It’s a Well-Known One
Microsoft’s revenue from Windows and Office products is undoubtedly not immune to a decline in the PC market. Since the pandemic had a significant positive impact on the PC market, this year has seen a general stabilization of demand for PCs:
Even though the PC market’s decline will pressure Office and Windows income, the Windows operating system continues to dominate, and Office products have a high degree of stickiness. Microsoft has announced a 15–25% price hike for the Office product family, which is a blatant sign of pricing power—a quality that is highly coveted in an environment where inflation is on the rise. Overall, even while there is no doubt that the PC industry is slowing down after COVID-19, markets ought to have already factored in the effect because nothing lasts forever.
The Recent Decline Is an Opportunity to Buy Microsoft Stock
According to Microsoft’s FY23 estimate, top-line growth would be double-digit with a 4% FX impact. This demonstrates the somewhat defensive and sturdy quality of the company’s offerings, which, in my opinion, should reduce the danger of downward revisions. The predicted FY23 operating margin of 42% and FCF margin of 33% still make Microsoft a force in the profits department, even though operating margins are expected to remain flat (favorable depreciation schedule impact offset by FX).
Although Microsoft’s stock valuation isn’t relatively low, I believe that careful positioning and unfavorable investor sentiment will pave the way for future performance that is better than anticipated. I, therefore, view the current decline in the share price as a buying opportunity at 24.5x ahead earnings / 3.9% forward FCF yield and will begin to get more aggressive should valuation overshoot to the downside to 20x or $200 per share.
Featured Image – Megapixl © Maislam
