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Microsoft - cloud underpins earnings beat

Excluding the impact of exchange rates, third quarter revenue rose 21% to $49.4bn, driven by strong growth across all segments...

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Excluding the impact of exchange rates, third quarter revenue rose 21% to $49.4bn, driven by strong growth across all segments. Intelligent Cloud was the strongest performer, but Productivity and Business Processes also delivered double-digit growth.

Operating income rose 23% to $20.4bn, despite a 21.2% increase in research and development as well as a 25.8% rise in service costs. This was slightly ahead of market expectations.

Microsoft returned $12.4bn to shareholders through buybacks and dividends during the period, a 25% increase.

Microsoft shares were broadly flat in after-hours trading.

Fourth quarter revenue is expected to be between $52.4bn and $53.2bn, including the impact of the war in Ukraine. Shutdowns in China have also been accounted for, though if they extend into May there could be a further negative impact.

View the latest Microsoft share price and how to deal

Our view

Microsoft's main attraction lies in selling software the world truly doesn't know how to live without. Add to that the group's ballooning cloud computing offer and you have an enviable stable of businesses in today's working environment.

CEO Satya Nadella's said the group will thrive in a belt-tightening environment, because it helps companies do more with less. So far that seems to be the case as Microsoft revenues remain relatively insulated from cutbacks in response to inflation.

Classics, like Office 365, as well as newer business management software like Dynamics are landing well with customers. And they're increasingly 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.

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.

Microsoft's highly cash generative core business means it's one of the few companies in the world that can afford a yearly capital expenditure bill upwards of $20bn. Building a software platform is expensive and time consuming, but once it's up and running adding new customers is essentially costless. Microsoft's sitting on a net cash pile of about $55bn, and that's despite a busy year of acquisitions.

Speaking of which, the Activision Blizzard acquisition is an attraction in our view.

The deal will allow Microsoft to beef up its existing gaming products, especially in the lucrative subscription-based Game Pass. Snatching up some of the world's most valuable intellectual property in this way is a refreshingly useful way to spend some of Microsoft's enormous cash hoard. Luckily for Microsoft, Xbox revenues seem to be holding their own - padding out the nest for Call of Duty to land.

Microsoft is offering a prospective yield of 0.9%. Although it should be remembered that dividends are not guaranteed and past performance is not a guide to the future.

We should note Microsoft hasn't been immune to the wider tech sell off sparked by rising inflation and expectations for interest rate hikes. There's little the group can do about wider economic rumblings, but we may not have seen the last of short-term challenges, and all ears are firmly honed-in on where interest rates are headed next. The shutdowns in China also have the potential to derail growth somewhat if they persist.

We think Microsoft has an incredible market position and offers genuine long-term opportunity. It's also worth considering the price to earnings ratio doesn't appear too demanding, though it's some way above the long-term average.

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.

Third Quarter Results

A 32% increase in server products and cloud services meant Intelligent Cloud saw revenue rise 26% to $19.1bn. This fed into a 28.9% increase in operating profits to $8.3bn. The division now makes up roughly 40.7% of overall profit, up from 37.7% last year.

Operating profits in Productivity and Business Processes, which houses the Microsoft Office suite, rose from $6.0bn to $7.2bn. Revenue was up 17% to $15.8bn, reflecting low double digit growth in Office Commercial and Consumer and a 35% rise in LinkedIn revenue.

More Personal Computing saw an 11% revenue increase to $14.5bn. This was comprised of growth in Windows products as well as 6% increase in Xbox content and services revenue. Operating profits rose 6.6% to $4.9bn.

Free cash flow, excluding acquisition costs, was $20.0bn, up from $17.1bn due to higher profits. Net cash was $54.8bn, down from $72.2bn.

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
Laura Hoy
Laura Hoy
ESG Analyst

Laura is part of HL's ESG analysis team, working to offer research and analysis to help with sustainable decision making. She also works with other parts of the business to help integrate ESG.

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Article history
Published: 27th April 2022