On Thursday, Jan. 30, Microsoft Corp. (MSFT, Financial) reported financial results for its second quarter of fiscal 2020. It was another great quarter for the company, with revenues climbing 14% to $36.9 billion (up 15% on a constant currency basis) due to growth across each of the company’s three business segments and across all major geographies. Operating income grew at a much faster pace than revenues (up 35% year over year) due to meaningful margin expansion (up 600 basis points to 37.6%), with diluted earnings per share (EPS) increasing by 37% to $1.5 per share. For the year, management now expects roughly two points of operating margin expansion.
I’ve said this before, but it’s worth repeating: anybody who has followed Microsoft over the past decade can appreciate just how unlikely these kind of results seemed a few years ago. Management and employees deserve a ton of credit for the results they’ve delivered in recent years.
Commercial Cloud revenues (Office 365 Commercial, Azure, Dynamics Online and LinkedIn Commercial) were $12.5 billion, up 39% year over year (+41% in constant currencies). Run rate Commercial Cloud revenues are now at $50 billion – three times higher than at the end of FY17.
As shown below, Azure constant currency revenue growth actually accelerated slightly in the quarter (analysts at Goldman Sachs estimate that the business now generates annual revenues of roughly $20 billion, with 95% of Fortune 500 companies trusting Azure for their mission-critical workloads.).
In addition to roughly 40% year over year growth, commercial cloud continues to benefit from economies of scale and increasing mix shift towards premium services, with gross margins up 500 basis points to 67% (“driven again by material improvement in Azure gross margin percentage, which more than offset sales mix shift to Azure”). As a result, commercial cloud gross profit dollars increased by 53%, compared to 46% growth in the first quarter.
Productivity & Business Processes revenues increased 19% (constant currency) to $11.8 billion on the back of strength in Office 365 Commercial (21% seat growth and 27% revenue growth from continued mix shift to higher APRU offerings), LinkedIn (20%+ revenue and sessions growth) and Dynamics (with Dynamics 365 revenues up more than 40% year over year). In addition to revenue growth, Productivity & Business Processes operating margins expanded 400 basis points to 44%, resulting in segment operating income growth of 29%.
Intelligent Cloud revenues were $11.9 billion (+28% in constant currencies), driven by the previously discussed strength from Azure. The segment reported significant operating margin expansion as well (up 320 basis points to 38.2%), resulting in operating income growth of 38%.
In More Personal Computing (MPC), revenues increased 2% due to 26% growth from Windows OEM Pro, with higher demand in advance of end of support for Windows 7. That increase was offset by weakness in gaming, largely due to anticipation for the new Xbox console that will be released later this year. More importantly, Xbox Live active users reached another new high, which points to the continued engagement with the service among gamers.
Through the first six months of the year, cash flow from operations increased 9% to $24.5 billion. Capital returns to shareholders in the first half were $10.1 billion of repurchases (flat with the first half of 2019) and $7.4 billion of dividends (up 9%, which reflects the 11% increase in the quarterly dividend to $0.51 per share). The total share count is only down 1% year over year, but that should change if the company doesn’t engage in any additional stock-based acquisitions (remember that Microsoft acquired GitHub in 2018 in a $7.5 billion all-stock deal).
At quarter's end, the company had roughly $64 billion in net cash on the books ($8 per share). Considering that the business has generated more than $100 billion of cumulative free cash flow over the past three years, I continue to believe that this positioning is incredibly conservative.
Conclusion
Over the past five years, Microsoft shares (total return) have compounded at well over 30% per annum. As shown below, these outsized gains have been supported by a significant increase in the company’s price-earnings multiple.
Of course, that multiple expansion speaks to what I said earlier: recent results are miles ahead of what the company could reasonably expect to deliver five years ago. The reality today is that Microsoft is now in a position to deliver sustained double-digit earnings per share growth. They are a clear leader in huge addressable markets that should see a tailwind from structural growth for many years to come (and should also benefit from economies of scale, along with other advantages that Microsoft brings to the table relative to its competitors). I remain of the opinion that you would be hard pressed to find any large company that matches Microsoft in terms of its long-term growth prospects, high-quality leadership and financial strength.
I’ll let CEO Satya Nadella have the last word:
“Tech spend as a percentage of GDP is projected to double over the next decade. At Microsoft, we are focused on building the most differentiated tech stack to enable every organization in every industry to build their own digital capability and tech intensity, with a business model that is trusted and aligned with their success in this new era.”
Disclosure: Long Microsoft.
Read more here:
- Apple: A Hot Start to 2020
- You Can Really Hold Them at Extraordinary Levels
- Union Pacific: Navigating Volume Pressures
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