As a major tech giant, Microsoft Corp. (MSFT, Financial) has continued to hold a strong leadership position, despite many of its competitors being disrupted over the past several decades. The new leadership position the company has recently forged is in the space of artificial intelligence, following a $10 billion investment in OpenAI. Microsoft has also continued to grow its core business segments.
In this discussion, I will break down the company’s solid earnings results for the second quarter of 2023. Let’s dive in.
Stellar financials
Microsoft recently reported strong financial results for the second quarter. Its revenue rose to an impressive $56.20 billion, marking an 8% year-over-year increase and surpassing analyst forecasts by $698.60 million.
This top-line result was driven by huge growth in the cloud with $30.3 billion in revenue reported, up 21% year over year.
Microsoft Azure is now fast approaching Amazon's (AMZN, Financial) AWS. Together, these two cloud providers dominate the market, with Alphabet's (GOOG, Financial) Google Cloud trailing in third place.
The company's Azure Arc platform, which is used for multi-cloud environments, has continued to be tremendously successful, growing 150% year over year to 18,000 customers.
The average annualized value for long-term Azure contracts is the highest it has ever been. This has been enhanced by the huge tailwinds surrounding artificial intelligence, of which Microsoft has positioned itself as a leader, both in terms of infrastructure and applications.
Microsoft has even scored a surprising partnership with Meta Platforms Inc. (META, Financial), which enables the company's customers to leverage its Llama AI model.
In addition, the company recently rolled out its “Copilot” offering for Office 365. This tool directly integrates into Microsoft Teams, Powerpoint, Excel and many more applications.
I believe this is a stroke of genius as Microsoft’s traditional office applications were facing immense pressure of freemium offerings by Google, such as “Sheets” and “Slides.” However, with the deep integration of AI, Microsoft truly does have a unique selling point.
The copilot tool enables white-collar workers to create PowerPoints easier, analyze data and do much more.
Also due to Microsoft's unique investment in OpenAI and its vast infrastructure, the company is effectively vertically integrated across the entire technology stack.
Over in the world of coding, GitHub Copilot has proven to be immensely successful and is one of the most popular tools used by the world’s best coders.
Microsofts “Power Platform” has also surged in popularity, with a 75% quarter-over-quarter increase in users with over 63,000 organizations adopting it.
Consumer business segments
Microsoft's Office commercial products revenue rose by 13% year over year or 17% on a constant currency basis. The number of Microsoft 365 Consumer subscribers grew to a staggering 65.4 million, up 4% year over year.
LinkedIn continues to be the world's largest professional social network with close to 1 billion users. Its revenue rose by 8% year over year. This was surprisingly positive given the pullback in both recruiting (Talent solutions) and business-to-business marketing spend, driven by macroeconomic headwinds.
Microsoft’s only point of pain was its More Personal Computing business, which reported revenue of $13.3 billion, declining by 9% year over year or 7% on a constant currency basis.
This was driven by a macroeconomic pullback in PC computing and gaming. Windows OEM revenue plummeted by 28% year over year, despite the fact that Windows 11 was launched. Xbox content revenue did improve slightly, increasing by 3% year over year.
Strong profit and fortress-like balance sheet
Microsoft reported solid operating income of $24.2 billion, which rose 18% year over year. Its earnings per share also increased 21% to $2.69, beating analyst forecasts by 14 cents.
This result was driven by solid operating leverage with strong top-line growth and only a 4.32% increase in general and administrative expenses.
For Azure, the cloud gross margin rose by 3% to a super high 72%. Its operating margin was down slightly due to an unfavorable product mix.
Microsoft’s overall capital expenditures were $10.7 billion. The majority of this went toward bolstering the company's AI infrastructure to meet the future expected demand.
Despite large capex, Microsoft is still a cash cow with $28.8 billion reported, up 17% year over year. Free cash flow also rosed by 19% year over year.
During the quarter, the company returned $9.7 billion to shareholders in the form of buybacks and dividends, which is great news for existing investors.
Moving forward, Microsoft is expected to continue to fire on all cylinders. For the full year, Productivity and Business Processes revenue is expected to grow between 9% and 11%, generating approximately $18 billion.
LinkedIn is expected to continue with low to mid-single-digit growth, as its revenue faces headwinds from hiring.
Microsoft Azure is the real growth engine with a blistering 26% growth rate expected for the year.
Valuation
Since the start of 2023, Microsoft’s share price has risen by a solid 50%, which is fantastic for a major technology company. The company is not exactly cheap right now with a price-earnings ratio of 30, which is 3% higher than its five-year average.
Its forward price-sales ratio of 10.68 is also higher than its average over the same period.
The GF Value Line indicates a fairl value of $322 based on historical ratios, past financial performance and analysts' future earnings projections. Therefore, the stock is fairly valued currently.
Conclusion
Microsoft has produced some fantastic financial results. This should not be surprising since it has one of the greatest business models I have ever analyzed, from its market-leading Azure cloud platform to its deep relationships with enterprises who purchase its 365 applications. Then, of course, it has LinkedIn, Xbox and its leading Windows operating system.
The stock is not exactly “cheap” right now, but it is in a prime position to capture some of the immense value which is expected to be created from the growth in the AI industry.
