Last week, Microsoft (MSFT, Financial) won a $927 million contract from the U.S. Defense Department. This may be a drop in the bucket for the ubiquitous software giant, as it generated total sales of $85.3 billion last fiscal year. But the new contract shows there is no slowing down the 41-year-old tech giant.
In a review of its recent quarterly performance and overall financials, the software company reported on Oct. 20 a 0.36% growth in sales to $20.45 billion and a 4.3% loss in profits to $4.69 billion in its first quarter fiscal 2017. The negative change in its profits seem to be anticipated as Microsoft’s shares, in contradiction, rose 4.2% the day post-earnings release. The S&P 500 index closed flat in the same period.
“We are helping to lead a profound digital transformation for customers, infusing intelligence across all of our platforms and experiences.”
“We continue to innovate, grow engagement, and build our total addressable market.”
Satya Nadella, chief executive officer at Microsoft.
“Our first quarter results showed continued demand for our cloud-based services."
“We continue to invest, position ourselves for long-term growth, and execute well across our businesses.”
Amy Hood, executive vice president and chief financial officer at Microsoft.
Outlook
(Microsoft PowerPoint Presentation)
As per Microsoft’s outlook for its fiscal year 2017 operations, the company sees its operational expenses between $31.1 billion and $31.4 billion, which is lower in comparison to $32.4 billion in fiscal 2016.
Valuations
Microsoft had a trailing 12-month PE ratio of 30 times (industry median 24), PB ratio of 7 times (industry median 2.79) and PS ratio of 5.9 times (industry median 2). The company also had a trailing dividend yield of 2.32% with a 69% payout ratio and 2.1% share buyback ratio.
Market performance
Microsoft had outperformed the market on a year-to-date, five-year and 10-year basis. Year to date, the company had a total return of 16.6% versus the index’s 13% and on a five-year basis, Microsoft returned 21.5% versus 14.78%.
Microsoft
Microsoft operates a worldwide business in over 190 countries. According to its filing, Microsoft develops, licenses and supports a wide range of software products, services and devices that deliver new opportunities to people’s lives.
In addition to its numerous business operations, Microsoft also offers an array of services, including cloud-based solutions that provide customers with software, services, platforms and content. The company also delivers relevant online advertising to a global audience.
As of fiscal 2016, Microsoft had three business segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing.
(10-K and 10-Q)
Productivity and business processes
This segment consists of products and services in Microsoft’s portfolio of productivity, communication and information services, spanning a variety of devices and platforms.
The segment grew 0.2% in fiscal 2016 to $26.49 billion and contributed 31% to total Microsoft sales, while delivering an operating margin of 47% -- the highest among Microsoft’s segments. In first quarter 2017, the segment grew 5.6% and had a 46.9% margin.
Intelligent Cloud
The segment consists of Microsoft’s public, private and hybrid server products and cloud services that can power modern businesses.
Microsoft’s server products and cloud services, includes SQL Server, Windows Server, Visual Studio, System Center, and related CALs, as well as Azure. The company’s enterprise services includes Microsoft’s Premier Support Services and Microsoft Consulting Services.
In fiscal 2016, Intelligent Cloud grew 5.6% to $25 billion and contributed 29% to overall Microsoft sales. The segment also had a 37.4% margin, compared to 41.6% the previous year. In first quarter 2017 operations, Intelligent Cloud grew 8.3% and delivered a margin of 32.2%, compared to 40.6% year-on-year.
More Personal Computing
This segment consists of products and services geared towards harmonizing the interests of end users, developers and IT professionals across screens of all sizes.
Personal Computing is comprised of Microsoft’s Windows business, including patent licensing, Windows Embedded, MSN display advertising and Windows Phone licensing. In addition, Microsoft devices, including Microsoft Surface phones, PC accessories and Microsoft’s gaming business, such as Xbox hardware and subscriptions are all included in the segment. Lastly, the segment also included Microsoft’s search advertising business.
In fiscal 2016, Personal Computing had a negative 6.3% change to $40.46 billion and contributed 47% -- the largest among the three segments—in overall Microsoft sales. Personal Computing also had an operating margin of 15.2%, the smallest margin among the segments.
In the first quarter of 2017, Personal Computing had $9.29 billion in sales, compared to $9.46 billion it had the prior year. The segment also delivered a margin of 20.7%, compared to 16.1% the previous year.
Overall, Microsoft had a five-year sales and profit growth averages of 4% and -6.2%, respectively. Microsoft also had a five-year operating margin average of 69%.
Cash, debt and book value
As of Sept. 30, Microsoft had $136.9 billion in cash and $74.69 billion in debt with a debt-equity ratio of 1.06, compared to 0.50 the previous year. Microsoft had 10% of its $212.5 billion assets in goodwill and intangibles while having a book value of $70.4 billion, compared to $77.4 billion in September of last year.
Cash flow
(10-Q)
For its recent quarter, Microsoft grew its cash flow from operations by 30% to $11.5 billion. Most positive cash flow changes were observed in almost all contributing aspects of its business, such as receivables, deferred of unearned revenue, other current liabilities and other long-term liabilities.
(10-K and 10-Q)
Capital expenditures were $2.16 billion, leaving Microsoft with $9.4 billion, compared to $7.5 billion the previous year. Microsoft also allocated 76.3% of its free cash flow in shareholder dividends and share buybacks.
On average, Microsoft allocated 90.2% of its free cash flow in payouts in the past three fiscal years. Payouts per free cash flow have been increasing in recent years, except in its recent quarter year-on-year comparison, which may have broken this unappealing trend. Nonetheless, Microsoft also added $21.36 billion in debt for the period.
During the quarter, Microsoft announced a new share repurchase program authorizing up to $40 billion in share repurchases, and reaffirmed it is on track to complete its current $40 billion share repurchase program by Dec. 31.
Microsoft also has a huge amount of cash flow exchange in its investments. In the recent quarter, Microsoft allocated $57.18 billion in investment purchases while receiving $40.98 billion proceeds in investment sales and maturities.
Conclusion
As observed, there was a slowdown in Microsoft’s Office products and personal computing businesses. Specifically, Microsoft’s Personal Computing business exhibited a decline in growth, while it delivered higher profitability.
(10-K and 10-Q)
Microsoft’s Intelligent Cloud business, meanwhile, has exhibited an admirable growth on an annual and quarterly basis. Nonetheless, margins for the segment have been in a downward trend in recent times.
Microsoft’s $26.2 billion acquisition of LinkedIn in June demonstrated how Microsoft is more focused on enhancing sales growth in its most profitable business segment -- productivity and business processes. According to the Wall Street Journal, real synergy would be found between Microsoft’s Office productivity suite and LinkedIn’s core database of millions of professional profiles.
Meanwhile, balance sheet figures exhibited a little more leveraged than its past figures, while cash flow is substantial and supportive.
(Google Finance)
Wall Street analysts are getting more bullish on Microsoft in recent months. Wunderlich upgraded its outlook to a buy recommendation on Microsoft shares with a $70 a share price target; Goldman Sachs also changed its view to buy from being neutral with a $68 a share price. Five-year earnings multiple and profit growth averages and applying a 20% margin would indicate a value of about $25 a share.
In conclusion, Microsoft would be a pass.
Five-year earnings multiple: 15.8 times
Five-year profit growth average: -6.2%
Disclosure: I do not have shares in any of the companies mentioned.
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