Market Recon briefly...
Obviously, equity markets were punished on Tuesday in response to falling deposits at First Republic Bank FRC, weakness in the regional district manufacturing surveys out of both Dallas and Richmond, and a surprisingly poor headline result for the Conference Board's headline Consumer Confidence print for April.
Few were spared. All 11 S&P sectors traded lower, as nearly every single US equity market index suffered losses of well more than 1%. In fact, the Philadelphia Semiconductor Index and KBW Bank Index both surrendered more than 3% for the session.
Notably, both the S&P 500 and Nasdaq Composite gave up their 21 day EMAs (exponential moving averages) on Tuesday. This forced the swing trading crowd out of their longs. The Nasdaq Composite, in particular, came to rest just above its 50 day SMA (simple moving average). It would be crucial for US markets to see that line defended:
In order to defend that line, major, mega-cap names such as Alphabet (GOOGL) and Microsoft (MSFT) would have to come through with some positivity after the closing bell. This is that story. Or at least, part of it.
Microsoft Reports!!
On Tuesday evening, Microsoft released the firm's fiscal third quarter financial results. For the three month period ended March 31st, Microsoft posted GAAP EPS of $2.45 on revenue of $52.857B. Both of these numbers beat Wall Street's expectations for the quarter reported, as revenue generation was good for year over year growth of 7% (+10% in constant currency).
The firm's cost of that revenue increased 3.3% to $16.128B, leaving Microsoft with a gross profit of $36.729B (+8.8%). After accounting for R&D, sales & marketing, and administrative costs, the firm was left with operating income of $22.325B. This print was up 10% (+15% in cc) from a one year ago comparison. After adding other incomes and figuring in taxes, Microsoft posted net income of $18.299M, which was good for 9% growth (+14% in cc) from the year ago period.
Segment Performance
- Productivity and Business Processes generated revenue of $17.516B (+3%, beating expectations). This produced operating income of $8.639B (+20%, beating expectations). Office commercial and cloud driven revenue continues to grow as does Office 365 Commercial.
- Intelligent Cloud generated revenue of $22.081B (+1%, beating expectations). This produced operating income of $9.476B (+4.5%, beating expectations). Azure is the star of this unit, as the firm reported 27% growth here or 31% in constant currency. Azure is taking market share away from its rivals based on the strength of its AI (artificial intelligence) driven infrastructure. This is also a positive for Sarge-name Nvidia (NVDA) .
- More Personal Computing generated revenue of $13.26B (+9%, beating expectations). This produced operating income of $4.237B (+23%, beating expectations). PC demand surprised slightly to the upside. Gaming was down, hardware was significantly lower, and Windows OEM suffered a decline. That said, both the Edge browser and Bing search engine are benefiting from higher volumes and taking share from competitors.
Fundamentals
For the quarter reported, Microsoft generated operating cash flow of $24.441B, which was down 3.7% from the year ago comp, and just a touch lower than expected. CapEx grew significantly (+23.7%) from the year ago period to $6.607B. This left free cash flow at $17.834B, which was an 11% contraction from this quarter last year, but still around what Wall Street was looking for. Out of this number, the firm repurchased $5.059B in common stock and paid $5.059B in dividends to shareholders.
Turning to the balance sheet, Microsoft ended the quarter with a cash position of $104.427B and inventories of $2.887B. This puts current assets at $163.889B. Current liabilities add up to $85.691B. This includes $6.245B in debt labeled as current, but also $36.903B in unearned revenue, which is not a financial liability at all, but one of labor and/or services owed. This puts the firm's current ratio at a very healthy 1.91, but in reality, it's even better than that due to the sizable presence of those unearned revenues.
Total assets amount to $380.088B, including $77.819B in goodwill and other intangibles. At 20% of total assets, I do not see this as a problem. Total liabilities less equity comes to $185.045B. This includes long-term debt of $41.965B. I find it comforting that the firm could, if it needed to, pay off all of its long and shorter term debt more than twice over out of cash, and still have billions of dollars left over.
Guidance
There was no guidance provided in the press release. Investors had to wait for the post-earnings conference call. The guidance offered was complex, in depth and clear, which is more than we expect from most firms. That said, for the sake of brevity, I will try to abbreviate what was said, and highlight (in a less itemized) fashion, what was provided.
For the current quarter, Microsoft expects to suffer a negative FX-related impact of about two percentage points. Microsoft Cloud, supported by the firm's AI platform and consistent execution should "drive another quarter of healthy revenue growth." Microsoft Cloud gross margin in percentage terms, should be up roughly two points year over year, driven by accounting changes, Outside of that impact, fiscal Q4 cloud gross margin percentage will likely be relatively flat as improvements in Office 365 will offset lower Azure margin and the impact of scaling the firm's AI infrastructure in order to meet demand.
As for segment guidance, Productivity and Business Processes is expected to grow revenue from 10% to 12% in constant currency ($17.9B to $18.2B). This puts the mid-point of expectations at $18.050B, which is better than Wall Street was looking for. The Intelligent Cloud segment is expected to grow revenues from 15% to 16% in constant currency ($23.6B to $23.9B). This leaves the mid-point at $23.75B, which is slightly short of Wall Street's consensus view. More Personal Computing is seen posting revenue of $13.35B to $13.75, putting the mid-point at $13.55B, which is considerably better than expectations.
Slapped together, the segmented guidance leaves the firm looking at current quarter revenue of $54.85B to $55.85B, or $55.35B at the mid-point. This is about half a billion more in revenues than Wall Street had pieced together ahead of time.
Wall Street
Since these earnings were released last night, I have come across 19 sell-side analysts that both opined on MSFT and are rated at a minimum of four stars by TipRanks. Of these 19 analysts, after allowing for changes, 16 rate MSFT at a "buy" or their firm's buy-equivalent rating. There are two "hold" or hold-equivalent ratings and one outright "sell" rating. One of the "buys" chose not to set a target price, so we are working with 18 targets.
The average target price across these 18 analysts is $307.39, with a high of $350 twice (Alex Zukin of Wolfe Research and Sami Badri of Credit Suisse), and a low of $232 (John Difucci of Guggenheim). Once omitting one of the highs and the low as potential outliers, the average target across the other 16 rises to $309.44. Just as an FYI, that average target across the 15 "buys" was $313, while the average of the two "holds" was $303.
My Thoughts
What's to say? Long-time readers know that I am long MSFT and that I am probably to some degree biased. Readers already know that I think CEO Satya Nadella is one of the smartest individuals that I have ever listened to.
Earnings were solid. Each and every segment beat expectations. Guidance, overall, was better than expected. Cash flows are strong. The balance sheet is even stronger.
If one listened to, or read through the call, then one knows that Microsoft is focused on leveraging what it sees as a lead in artificial intelligence to aggressively go after market share in businesses that the firm perceives as vulnerable to disruption.
Readers already know that we had placed a $304 target price on MSFT based on the $264 pivot created by that double bottom reversal pattern outlined in purple above that took most of late autumn into winter to develop. We now see the early November bottom as the start of a Pitchfork model that remains intact.
The stock will trade higher Wednesday, both in response to these earnings as well as to the news that the Activision Blizzard (ATVI) deal has been blocked in the U.K. The trick for Wednesday will not be just in retaking the 21 day EMA, but in at least holding that line.
At this point, I reiterate my $304 target as that is pretty close to where the central trendline of our Pitchfork runs through the end of the chart. I will add this... the trend in place does leave open the door to prices as high as $330. No, I am not selling any Microsoft ahead of my target being reached at a minimum. I do see the 50 day SMA, which has worked nicely twice already in 2023, as a good place to add on any coming broad market weakness.
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