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Microsoft - cloud drives revenue growth as profits fall

First quarter revenues were up 16% to $50.1bn ignoring currency movements.

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First quarter revenues were up 16% to $50.1bn ignoring currency movements. Cloud revenue now accounts for over half of revenue and outpaced the wider business with growth of 31%, but at a slower rate than expected for the second quarter running.

The consumer side of the business which includes the likes of Xbox, showed the weakest comparative performance, up 3%, with pre-installed versions of Windows dropping 15%.

Net income was down 8% to $17.6bn, with gross margins down 0.7 percentage points and research and development costs up 18% to $6.6bn.

Free cash flow fell 9.7% to $16.9m and net cash was up from $55.0bn to $58.6bn.

Microsoft returned $9.7 billion to shareholders in the form of share repurchases and dividends, down 11%.

Microsoft is expecting second quarter revenue of $52.35bn to $53.35bn, some way below the prevailing market expectation of $56.1bn.

The shares fell 6.7% in after hours trading.

View the latest Microsoft share price and how to deal

Our view

Rising prices together with tepid demand are expected to persist for the foreseeable, and the shaky start to the financial year means Microsoft has its work cut out to generate earnings growth for the 12 months as a whole. This quarter's profit decline is a far cry from the 20%+ growth investors had been enjoying. But Microsoft's portfolio of software and IT infrastructure products still has a lot of long-term appeal.

Microsoft is an enviable mashup of great businesses. It makes products none of us can live without and owns an increasingly valuable stable of subscription-based products like LinkedIn and Office 365 Commercial. Plus, the pandemic kicked the door wide open for Microsoft's cloud arm, creating a growth runway that stretches well into the future.

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.

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 of software programmes and it could be an attractive niche. So far customers seem to be lapping it up, but if budget cuts are on the agenda Microsoft may find it more difficult to upsell its offerings.

But building out this kind of infrastructure doesn't come cheap. Expenditure was nearly $24bn last year and that's expected to rise in the double digits over the next few years.

Such heady investment requirements mean not everybody can afford a seat at the table. Microsoft is one of the select few businesses which can, thanks to a highly cash generative core business. Building a software platform is expensive and time consuming, but once it's up and running adding new customers is essentially costless - extra revenue drops quickly through to profit.

That's left the group with plenty of firepower to make strategic acquisitions. Microsoft's planning to bring game-maker Activision Blizzard under the umbrella pending an investigation by the UK's Competitions and markets Authority, with an outcome expected by March next year. That will chip away at the group's balance sheet, but it should also stoke growth for its languishing personal computing arm, which comprises the likes of Xbox, and pre-installed versions of Windows on personal computers.

Ahead of this massive purchase, Microsoft's sitting on a net cash pile worth over $50bn, even after some $20bn in acquisition costs. This has left plenty of space to return cash to shareholders through share buybacks and dividends. So far this year Microsoft has scaled back on this.

The price/earnings ratio has come down sharply in the last year but remains above the long-term average, leaving it exposed to any deterioration in the business outlook.

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.

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.

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Written by
Derren Nathan
Derren Nathan
Head of Equity Research

Derren leads our Equity Research team with more than 15 years of experience in his field. Thriving in a passionate environment, Derren finds motivation in intellectual challenges and exploring diverse ideas within his writing.

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Article history
Published: 26th October 2022