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Microsoft - AI demand sees Microsoft beat expectations

Revenue rose 10% to $56.2bn in the fourth quarter, better than analysts expected.

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Revenue rose 10% to $56.2bn in the fourth quarter, better than analysts expected. This reflected a 23% increase in Cloud revenue, helped by increased AI demand. There were also double digit increases across Office products. Growth in these other areas offset declines from devices and licensing revenues.

Operating income rose 21% to $24.3bn, as the higher revenue combined with well-controlled costs saw margins improve.

Microsoft generated free cash flow of $19.8bn, with net cash of $64.0bn as at the end of June.

The group said it expects revenue in the new quarter to be $53.8bn - $54.8bn, which was lower than analysts expected. The slower rate of growth reflects the part of the business that relies on Windows.

Microsoft shares fell 4.1% following the announcement.

View the latest Microsoft share price and how to deal

Our view

Microsoft's dealing with a marked slowdown in personal computing revenues, which reflects the incredibly challenging consumer environment. Buying a new laptop and the software that comes with it is simply not a priority for many people right now. Luckily for Microsoft, Cloud is picking up the slack, driven by accelerated demand thanks to Artificial Intelligence developments.

After purchasing a major stake in OpenAI, Microsoft is top of the pack when it comes to potential monetisation of Artificial Intelligence (AI). AI can be integrated into the majority of Microsoft's existing products, significantly raising revenue and margin ceilings in these areas. By doing this, the appeal of Microsoft's products should increase, which will help culminate in better pricing dynamics. This doesn't just apply to the ChatGPT side of things, Microsoft's own cloud security offerings should stand to benefit as businesses seek to up their defences against AI attacks.

The potential scale of the AI market is very exciting. But that doesn't mean it's a guaranteed cash cow. Huge advances like this often come with ups and downs and unpredictable competition dynamics. We suspect the reason investors were disappointed with recent results was because hopes were too high when it came to AI and the expectation of more detailed information. Regulatory risk is also a hurdle. The lack of intricate understanding in regulatory bodies increases the risk of impractical or damaging regulation coming into force, which is something that will need to be monitored closely.

So, while AI sparks into life in the background, it's important to keep an eye on the core business.

There are challenges, especially in Personal Computing. A broader decline in demand for hardware means devices aren't flying off the shelves, and manufacturers aren't paying as much to install Windows on their own kit. But overall, we still think Microsoft is an enviable mashup of great businesses. It makes products we can't live without and owns an increasingly valuable stable of subscription-based products like LinkedIn and Office 365 Commercial.

And let's not forget the traditional cloud business which has strong prospects. The brave new world includes updated versions of old classics, like Office 365, as well as newer business management software like Dynamics. Increasingly those are being delivered as cloud-based services rather than desktop software programs. Through Azure, Microsoft provides customers with the necessary 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, giving corporate customers more freedom to scale up their tech offerings quickly.

Microsoft key facts

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.

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Written by
Sophie Lund-Yates
Sophie Lund-Yates
Lead Equity Analyst

Sophie is a lead on our Equity Research team, providing research and regular articles on a selection of individual companies and wider sectors. Sophie's specialities are Retail, Fast Moving Consumer Goods (FMCG), Aerospace & Defence as well as a few of the big tech names including Facebook and Apple.

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Article history
Published: 26th July 2023