Microsoft MSFT is set to release its fiscal second-quarter earnings report on Jan. 29. Here’s Morningstar’s take on what to look for in Mircosoft’s earnings and stock.
Key Morningstar Metrics for Microsoft
• Fair Value Estimate: $490.00• Morningstar Rating: ★★★★
• Economic Moat: Wide
• Morningstar Uncertainty Rating: Medium
Earnings Release Date
• Wednesday, Jan. 29, after the close of trading
What to Watch for in Microsoft’s Fiscal Q2 Earnings
• Capital expenditure and new guidance: This is in light of the surge in data center capacity expansion, and made more interesting by the Stargate announcement earlier this week.
• Azure performance: Growth should be accelerating, even modestly. Microsoft has been operating at capacity within Azure, somewhat limiting growth.
• AI commentary: We’re curious about how AI relates to the demand for both Azure and products like M365 Copilot or GitHub Copilot.
Microsoft Stock Price
Source: Morningstar Direct.
Fair Value Estimate for Microsoft
With its 4-star rating, we believe Microsoft’s stock is undervalued compared with our long-term fair value estimate of $490 per share, which implies a fiscal 2025 enterprise value/sales multiple of 13 times and an adjusted price/earnings multiple of 38 times.
We model a five-year compound annual growth rate for revenue of approximately 13% inclusive of the Activision acquisition. We envision stronger revenue growth ahead, as Microsoft’s prior decade was bogged down by the 2008 downturn, the evaporation of mobile handset revenue from the disposal of the Nokia handset business, and the onset of the model transition to subscriptions (which initially resulted in slower revenue growth). However, we believe macro and currency factors will pressure near-term revenues.
Read more about Microsoft’s fair value estimate.
Microsoft Stock vs. Morningstar Fair Value Estimate
Source: Morningstar Direct.
Economic Moat Rating
We assign Microsoft overall a wide moat primarily due to switching costs, with network effects and cost advantages as secondary sources. We believe Microsoft’s moat will allow the company to earn returns above its cost of capital over the next 20 years.
We believe customers value the firm’s products as stand-alone solutions and its immense breadth of products, and these applications are tightly integrated. In our opinion, the strength of these products is crucial but should not overshadow the importance of all the solutions Microsoft offers under one umbrella, as customers are usually looking to consolidate vendors. As Microsoft offers a wider set of related and compelling solutions, we believe it becomes more entrenched as customers adopt multiple products.
Read more about Microsoft’s economic moat.
Financial Strength
We believe Microsoft enjoys excellent financial strength because of its strong balance sheet, growing revenue, and high and expanding margins. As of June 2024, it had $76 billion in cash and equivalents, offset by $52 billion in debt, resulting in a net cash position of $24 billion. Gross leverage is at 0.5 times fiscal 2024 EBITDA. Our base case assumes healthy revenue growth, driven by Azure public cloud adoption, Office 365 upselling efforts, AI adoption, and broader digital transformation initiatives. We see strong margins improving further over the next several years. The free cash flow margin has averaged 30% over the last three years, which we expect to generally improve.
Read more about Microsoft’s financial strength.
Risk and Uncertainty
We assign Microsoft a Morningstar Rating of Medium. The company’s risks vary among its products and segments. High market share in the client-server architecture over the last 30 years means significant high-margin revenue is at risk, particularly in OS, Office, and Server. Microsoft has thus far been successful in growing revenues in a constantly evolving technology landscape, and it’s enjoying success in both moving existing workloads to the cloud for current customers and attracting new clients directly to Azure. However, it must continue to drive revenue growth of cloud-based products faster than revenue declines in on-premises products.
Microsoft is acquisitive, and while many small acquisitions are completed that fly under the radar, the company has had several high-profile flops, including Nokia and aQuantive. The LinkedIn acquisition was expensive but served a purpose and seems to be working well. It is not clear how much Microsoft bought in the Permira-led Informatica LBO, and it may have been an important strategic investment, but Informatica was certainly not a growth catalyst.
Read more about Microsoft’s risk and uncertainty.
MSFT Bulls Say
• Public cloud is widely considered the future of enterprise computing, and Azure is a leading service that benefits the evolution first to hybrid environments and ultimately to public cloud environments.
• Microsoft 365 continues to benefit from upselling into higher-priced stock-keeping units, which should continue over the next several years.
• Microsoft has monopoly-like positions in areas (OS, Office) that serve as cash cows to help drive Azure growth.
MSFT Bears Say
• Momentum is slowing in the ongoing shift to subscriptions, particularly in Office, which is generally considered a mature product.
• Microsoft lacks a meaningful mobile presence.
• Microsoft is not the top player in its key sources of growth, notably Azure and Dynamics.
This article was compiled by Aman Dagra.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
