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Microsoft - Cloud continues to drive performance

Nicholas Hyett | 24 October 2019 | A A A
Microsoft - Cloud continues to drive performance

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Microsoft Corporation Com Stk US$

Sell: 215.19 | Buy: 215.29 | Change 1.36 (0.64%)
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Microsoft's first quarter results have come in comfortably ahead of analyst expectations. Underlying revenue rose 14% to $33.1bn, with operating profits up 27% to $12.7bn.

The shares rose 1% on the news.

View the latest Microsoft share price and how to deal

Our view

Microsoft's early success was built on the Windows operating system, launched back in 1985.

The group's dabbled in several other markets over the years, launching the Xbox in 2001, and since 2017 has spent $34.5bn on the acquisitions of the professional network LinkedIn and code writing and sharing site GitHub. But new vistas area really opening up with the evolution of cloud computing.

Office 365 and Dynamics are cloud based services rather than individual software programs, and through Azure, Microsoft provides customers with computing power on a pay-as-you-go basis. This eliminates the need to pay for the storage and upkeep of servers. It's no surprise it's growing rapidly.

However, these clouds are grizzly and expensive rather than fluffy and carefree. Building out the infrastructure behind the system means capital expenditure is likely to stretch past $16bn this year. It was under $6bn as recently as 2015.

Still, we think there's a silver lining to the extra costs. Massive investment requirements mean not everybody can afford a seat at the table. But with a net cash position already in excess of $60bn, plus operating cash flows of over $50bn, Microsoft is in a select group of companies that can.

In recent times it's even had enough left over to return cash to shareholders through share buybacks and dividends. The shares offer a prospective yield of 1.5% next year.

As things stand it looks like being a three-way cloud carve up. Amazon is the market leader, while Google-owner Alphabet is building its capability from a lower base. That puts Microsoft in the middle of the pack. Its focus is on making Azure an adaptable product, that can sit together with any existing computing power. This should be an attractive niche, although only time will tell.

The market thinks a steady core business and higher growth new ventures means Microsoft can generate impressive profit growth. We're inclined to agree, although there are no guarantees. With a price to earnings ratio of 25, well above the group's longer term average, the pressure is on to deliver.

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First quarter results (changes at constant exchange rates)

Revenue in the Intelligent Cloud business rose 29%, to $10.8bn. Azure, Microsoft's flagship cloud business, saw revenues grow 63%, driving the overall server and cloud category revenues 33% higher. Microsoft's Support and Consulting services also increased. Divisional operating profit rose 33% to $3.9bn.

In Productivity and Business Processes, revenue rose 15% to $11.1bn with operating profits rising 23% to $4.8bn. Office Commercial and Consumer revenues increased by 15% and 6% respectively - both increases driven by Office 365 products. LinkedIn revenues rose 26% and revenues in the HR and customer relationship management business grew 16%.

More Personal Computing revenue was $11.1bn, up 5%, driven by improved revenues from original equipment, search and Windows 10. Xbox revenues were flat and Surface (Microsoft's answer to the iPad) revenues declined 2%. Operating profits in the division rose 28% to $4bn.

Free cash flow in the quarter rose 4% to $10.4bn. Net debt rose 8.9% in the quarter to $67.1bn. Microsoft returned $7.9bn to shareholders in the form of share repurchases and dividends over the quarter.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.