Microsoft (MSFT) reported fourth quarter results for fiscal 2018 on Thursday.
Revenues exceeded $30 billion in the quarter, an increase of 15% over the year-ago period (in constant currencies). For the fiscal year, revenues were $110 billion – up 13% over fiscal 2017.
As I noted last time I wrote about Microsoft, commercial cloud has been growing at an astounding pace. That continued throughout fiscal 2018, with revenues up 53% in Q4 to $6.9 billion. Azure, Office 365 Commercial and Dynamics 365 reported growth of 85%, 35% and 56%, respectively. Run rate commercial cloud revenues are now at $27.6 billion – up about 130% from the end of fiscal 2016, and equal to nearly 25% of Microsoft’s revenues. When a quarter of your business is growing 50% year over year, that’s a nice tailwind (obviously that rate can only be sustained for so long).
In addition to revenue growth, commercial cloud gross margins continue to expand across all of Microsoft’s cloud services; in the fourth quarter, they were up 600 basis points to 58% (and up 100 basis points from the third quarter). We should see continued margin expansion in fiscal 2019. As in recent quarters, economies of scale in commercial cloud are materializing as expected (there’s also a benefit as customers adopt higher APRU offerings, as we’re seeing with Office 365).
As CFO Amy Hood noted on the conference call, there’s momentum heading into 2019:
“Customer commitment to our cloud platform continues to increase. In fiscal year 2018, we closed a record number of multi-million dollar commercial cloud agreements and more than doubled the number of $10 million-plus Azure agreements. Our annuity mix increased 3 points year over year to 89%. As a result, commercial bookings increased 18% even with a strong prior year comparable. Commercial unearned revenue was $29 billion, growing 21% in constant currency, significantly higher than anticipated due to stronger than expected cloud billings.”
Microsoft’s non-GAAP operating income was over 17% in fiscal 2018, driven by a combination of revenue growth and margin expansion (the non-GAAP part relates to restructuring charges in the prior year). This is most apparent in the Intelligent Cloud segment, where 18% revenue growth and about 250 basis points of operating margin expansion resulted in 26% Ebit growth for the year.
In fiscal 2018, Microsoft spent more than $10 billion on capital expenditures, repurchases and dividends. Despite these large outlays, they only accounted for about 80% of cash flow from operations. The cash and equivalents balance was $134 billion at year-end, with roughly $60 billion in net cash (around $8 per share). The reality is that Microsoft, like many of its large cap tech peers, has more money than it knows what to do with. I think that’s a good problem to have.
Diluted earnings per share increased by 16% in fiscal 2018 to ~$3.9 per share. At $104, even if you back out the net cash (which isn’t “correct” because you’re still giving them credit for net interest income), the stock is at ~25x trailing earnings. That's probably a forward P/E of ~22x or so. Clearly, Mr. Market is much more optimistic about Microsoft’s future than he was a few years ago.
With that said, I think this renewed sense of optimism is largely justified. Between solid top-line growth, some profit margin expansion, and significant financial flexibility that gives a capable management team the capacity to engage in share repurchases and large scale M&A (see the strong results from LinkedIn), I think double-digit EPS growth is attainable for the foreseeable future. While I won’t be adding at current levels, I continue to hold a meaningful position in Microsoft.
I still think this conclusion (from my 2017 year-end review) is fair:
“I like the idea of being Satya Nadella's business partner for the long-term, even if I'm not in love with the price I'm being asked to pay for that privilege. For that reason, I feel comfortable being slow to recognize gains and continue holding a sizable position in Microsoft.”
Disclosure: Long MSFT.
