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Microsoft - revenues rise as cloud takes off

Nicholas Hyett, Equity Analyst | 30 April 2020 | A A A
Microsoft - revenues rise as cloud takes off

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Microsoft Corporation Com Stk US$

Sell: 286.26 | Buy: 286.29 | Change -3.89 (-1.34%)
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Microsoft's third quarter revenues rose 16% at constant exchange rates to $35bn, driven by commercial, consumer and cloud customers. Operating profit rose 28% to $13.0bn.

CEO Satya Nadella said "We've seen two years' worth of digital transformation in two months. From remote teamwork and learning, to sales and customer service, to critical cloud infrastructure and security - we are working alongside customers every day to help them adapt and stay open for business in a world of remote everything".

The group returned $9.9bn to shareholders in the quarter through dividends and share buybacks, with around 40% returned in dividends.

The shares rose 2.2% in pre-market trading.

View the latest Microsoft share price and how to deal

Our view

The emergence of cloud computing has opened up new vistas for Microsoft. So far the coronavirus storm has done little to dampen progress and may even have provided something of a tailwind.

The brave new world includes updated versions of old classics, like Office 365, as well as newer commercial software products like Dynamics, all delivered as cloud based services rather than desktop software programs. Through Azure, Microsoft provides customers with computing power on a pay-as-you-go basis, eliminating the need for companies to pay up front 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 $15bn 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 $70bn, and the hugely cash generative software businesses churning out operating cash flows of over $50bn a year, Microsoft is in a select group of companies that can.

The group's even had enough left over to return cash to shareholders through share buybacks and dividends. The shares offer a prospective yield of 1.2%, and that looks set to continue through the current crisis.

As things stand it looks like Cloud will be a three-way 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. Combine that with a back catalogue to software programmes and it could be an attractive niche. So far customers seem to be lapping it up.

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. A price to earnings ratio of 29 is well above the group's longer term average though, so the pressure is on to deliver.

Third Quarter Results (Constant Currency)

The Productivity & Business Processes division saw sales rise 16% to $11.7bn. That reflects good growth across all products, including cloud based Office products for both commercial and consumer customers and a 22% uplift in LinkedIn revenues. Reported operating profits in the division rose 20.3% to $4.8bn.

Intelligent Cloud revenues rose 29% to $12.3bn, with Azure revenues up 61%, as reported operating profits rose 42.1% to $4.6bn. Revenues in More Personal Computing rose 4% to $11bn. Pre-installed Windows sales flat year-on-year with only modest growth in Xbox and search revenues. Divisional reported operating profits rose 15% to $3.6bn.

With operating costs increasing slower than revenues, profit margins improved. However, Microsoft did increase Research & Development spending by 13.2% in the year to $4.9bn, and capital expenditure rose substantially to $3.8bn, up 46.9%.

Free cash flow in the quarter was $13.7bn, up around 25% year-on-year. Net cash on the balance sheet at the year-end stood at $71bn.

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