Microsoft Earnings: Cloud Growth to Accelerate This Year

Key
Morningstar
Metrics
for
Microsoft

• Fair
Value
Estimate:
$490
• Morningstar
Rating:
3
stars
• Morningstar
Economic
Moat
Rating:
Wide
• Morningstar
Uncertainty
Rating:
Medium

In
an
earnings
call
packed
with
new
data
points
around
artificial
intelligence-related
demand,
which
were
impressive,
in
our
view,
the
single
most
important
item
was
guidance
that
calls
for
Azure
revenue
to
accelerate
in
the
second
half
of
the
year
as
the
current
surging
investment
in
data
center
capacity
comes
online.
Therefore,
we
raised
our
revenue
growth
estimates
for
the
medium
term,
and
we
also
tweaked
our
profitability
assumptions
higher
based
on
consistently
good
performance
and
a
solid
outlook.
Revenue
was
again
governed
by
data
center
capacity
constraints
and
several
pockets
of
slight
weakness
arising
in
Europe.
With
shares
down
slightly
afterhours
following
a
recent
pullback,
we
see
the
stock
as
attractive.

We
see
results
reinforcing
our
long-term
thesis,
which
centers
on
the
proliferation
of
hybrid
cloud
environments
and
Azure.
The
firm
continues
to
use
its
on-premises
dominance
to
allow
clients
to
move
to
the
cloud
at
their
own
pace.
We
center
our
growth
assumptions
around
Azure,
Microsoft
365
E5
migration,
and
traction
with
the
Power
Platform
for
long-term
value
creation.
AI
is
also
quickly
supplementing
growth,
which
we
see
as
another
secular
driver.

For
the
June
quarter,
revenue
increased
15%
year
over
year
to
$64.73
billion,
compared
with
the
midpoint
of
guidance
of
$64.00
billion.
Activision
added
about
$1.68
billion,
or
3
points
of
growth,
to
revenue.
Relative
to
the
year-ago
period,
productivity
and
business
processes
rose
11%,
intelligent
cloud
increased
19%,
and
more
personal
computing
expanded
14%.
Compared
with
guidance,
both
PBP
and
MPC
came
in
above
the
high
end,
while
IC
was
just
below
the
midpoint.
Good
sales
execution
and
sales
mix
toward
software,
away
from
hardware,
supported
margins.

Microsoft
Builds
on
AI
Leadership

We
see
near-term
demand
as
good,
based
on
stout
forward-looking
metrics.
Commercial
bookings
grew
19%
year
over
year
in
constant
currency
based
on
strength
in
large
Azure
deals,
while
remaining
performance
obligations increased
20%
year
over
year
to
$269
billion.
Renewals
also
remain
strong,
which
we
think
is
partly
driven
by
high
interest
in
AI
and
consistently
good
execution.

Intelligent
cloud
performance
was
critical
in
solid
results
this
quarter,
as
Microsoft
continues
to
distance
itself
from
the
pack
in
terms
of
AI
leadership.
Microsoft
cloud
revenue
increased
21%
to
$36.8
billion.
Azure
remains
the
key
driver,
growing
30%
in
constant
currency,
compared
with
guidance
of
30%-31%.
We
think
this
trivial
hiccup
is
to
blame
for
a
minor
after-hours
selloff
—
Azure
revenue
did
not
come
in
at
the
top
end
of
guidance.

As
management
has
been
saying
for
several
quarters,
the
company
is
capacity-constrained
within
Azure.
Said
another
way,
despite
the
book
of
business
being
$22
billion
quarter
and
despite
capacity
issues,
Azure
still
grew
30%
year
over
year,
which
is
impressive
and
signifies
a
thirst
for
AI
services
on
the
part
of
customers.
After
contributing
300
basis
points
to
Azure
growth
in
the
September
quarter,
600
basis
points
in
the
December
quarter,
and
700
basis
points
of
growth
in
the
June
quarter,
AI
workloads
drove
800
basis
points
of
Azure
growth
this
quarter.
Management
noted
that
Copilot
customers
grew
more
than
60%
sequentially,
while
Azure
AI
customers
grew
nearly
60%
year
over
year
to
more
than
60,000,
and
customers
are
already
coming
back
for
more
seats.

In
PBP,
office
and
dynamics
continue
to
power
performance
and
drove
solid
results.
Overall,
the
segment
revenue
was
up
11%
year
over
year.
Dynamics
increased
16%
in
constant
currency,
Dynamics
365
grew
20%
in
constant
currency,
and
Office
commercial
products
and
cloud
services
rose
13%
in
constant
currency.
Overall
small
and
medium
business
performed
reasonably
well,
but
continued
to
show
signs
of
moderation,
while
Copilot
add-ons
helped
per-seat
pricing.
Lastly,
management
disclosed
that
Teams
now
has
more
than
3
million
premium
seats.

Activision
Deal
Bearing
Fruit

MPC
drove
the
most
upside
relative
to
the
company’s
guidance
for
the
second
consecutive
quarter,
with
the
year-over-year
comparison
distorted
by
the
Activision
acquisition.
Windows,
Activision,
and
search
and
advertising
all
performed
well
during
the
quarter,
which
supported
revenue
outperformance.
We
see
early
signs
of
success
for
the
Activision
deal,
with
Diablo
4
added
to
Game
Pass,
resulting
in
strong
user
adds
and
engagement.

Due
to
several
pressure
points,
including
the
Activision
headwinds
and
accounting
changes
for
server
depreciation,
margins
were
largely
in
line
with
our
expectations.
Margins
have
been
a
source
of
strength
for
most
of
our
coverage
in
recent
quarters.
Further,
Microsoft
continues
to
make
heavy
data
center
capacity
investments
that
will
pressure
gross
margin
in
fiscal
2025.
GAAP
operating
margin
was
43.1%,
compared
with
43.1%
last
year
and
the
midpoint
of
guidance
at
42.3%,
with
relative
strength
driven
by
continued
careful
cost
management
and
favorable
product
mix.
Regarding
mix,
Xbox
and
Surface
revenue
was
diminished,
while
Server,
Windows,
Azure,
and
other
software
solutions
were
strong.

Guidance
was
approximately
in
line
overall
for
the
first
quarter
relative
to
our
estimates,
with
revenue
being
slightly
shy
and
EPS
slightly
better.
Management
maintained
its
outlook
from
last
quarter
for
the
full
year,
which
included
double-digit
revenue
growth
and
a
1-percentage-point
decline
in
operating
margin.
The
outlook
for
the
September
quarter
calls
for
revenue
of
$63.8
billion-$64.8
billion
and
an
implied
operating
margin
of
approximately
45.1%
at
the
midpoint.
Microsoft
expects
Azure
to
grow
29%-30%
year
over
year
in
the
first
quarter,
which,
in
a
vacuum,
is
impressive.
However,
management
noted
that
heavy
capital
expenditure
investment
would
lead
to
capacity
coming
online
in
the
second
half
of
the
year,
allowing
Azure
growth
to
accelerate
from
already
high
levels.

Capex
is
expected
to
be
up
again
in
fiscal
2025.
On
this
point,
management
indicated
that
capex
was
overwhelmingly
related
to
Azure
this
quarter,
and
approximately
50%
of
capex
was
for
long-term
assets,
such
as
land
and
buildings,
while
50%
was
for
equipment,
including
servers
and
network
gear.
Microsoft
is
building
to
demand
signals
and
can
pull
back
on
the
equipment
side
of
the
equation
in
relatively
short
order
should
demand
materialize
more
slowly
than
expected.
Given
early
demand
signals
and
the
massive
success
of
similar
Azure
investments
more
than
a
decade
ago,
we
believe
these
investments
will
pay
off
for
the
company
and
investors.

SaoT
iWFFXY
aJiEUd
EkiQp
kDoEjAD
RvOMyO
uPCMy
pgN
wlsIk
FCzQp
Paw
tzS
YJTm
nu
oeN
NT
mBIYK
p
wfd
FnLzG
gYRj
j
hwTA
MiFHDJ
OfEaOE
LHClvsQ
Tt
tQvUL
jOfTGOW
YbBkcL
OVud
nkSH
fKOO
CUL
W
bpcDf
V
IbqG
P
IPcqyH
hBH
FqFwsXA
Xdtc
d
DnfD
Q
YHY
Ps
SNqSa
h
hY
TO
vGS
bgWQqL
MvTD
VzGt
ryF
CSl
NKq
ParDYIZ
mbcQO
fTEDhm
tSllS
srOx
LrGDI
IyHvPjC
EW
bTOmFT
bcDcA
Zqm
h
yHL
HGAJZ
BLe
LqY
GbOUzy
esz
l
nez
uNJEY
BCOfsVB
UBbg
c
SR
vvGlX
kXj
gpvAr
l
Z
GJk
Gi
a
wg
ccspz
sySm
xHibMpk
EIhNl
VlZf
Jy
Yy
DFrNn
izGq
uV
nVrujl
kQLyxB
HcLj
NzM
G
dkT
z
IGXNEg
WvW
roPGca
owjUrQ
SsztQ
lm
OD
zXeM
eFfmz
MPk