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Microsoft - top and bottom line misses as demand wanes

Fourth quarter revenue excluding the impact of exchange rates rose 16% to $51.9bn.

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Microsoft's fourth quarter revenue excluding the impact of exchange rates rose 16% to $51.9bn, driven by growth in all segments with particular strength in Intelligent Cloud. Product sales fell by around $1bn to $18.0bn while Service revenue improved from $27.2bn to $33.9bn.

Operating income was up 14% excluding the impact of exchange rates to $20.5bn slightly below market expectations for $21.1bn . Margins fell from 41.4% to 39.6% as the group revalued its server and network equipment and invested in cloud engineering, LinkedIn and Nuance.

A stronger US dollar impacted reported revenue and operating profits negatively by 4% and 6% respectively.

The group returned $12.4bn to shareholders during the period, a 19% year-on-year increase.

For the year ahead, the group expects double-digit growth in both revenue and operating profits.

Shares rose 3.7% in early trading.

View the latest Microsoft share price and how to deal

Our view

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.

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 this 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. Next year, Microsoft's planning to bring game-maker Activision Blizzard under the umbrella in the coming year. That will chip away at the group's balance sheet, but it should also stoke growth for its personal computing arm, in which Xbox is housed.

Ahead of this massive purchase, Microsoft's sitting on a net cash pile worth over $50bn, even after some $20bn in acquisition costs. This left plenty of space to return cash to shareholders through share buybacks and dividends. The prospective dividend may be modest at 1.0%, but total shareholder returns over the past twelve months have risen by more than 15% year-on-year, although remember dividends are not guaranteed.

Rising prices together with tepid demand are expected to keep profit growth in the mid-teens for the foreseeable. This is a far cry from the 20%+ growth investors had been enjoying and has shaved a fair amount from Microsoft's valuation, though it's still beyond the long-term average. This could be seen as an attractive entry point, but there are likely to be some bumps along the way.

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.

Fourth Quarter Results

Intelligent Cloud revenue rose 20% to $3.5bn. This was driven by 40% growth in Azure and other cloud services. Server products revenue fell 2% following last year's strong performance, offsetting demand for newly acquired Nuance and hybrid solutions. Operating income was up 11% to $894m despite a 20% increase in expenses due to investments in Azure and Nuance. Gross margins declined due server revaluations and a shift in the mix of products sold.

Revenue in Productivity and Business Processes rose 13% to $1.9bn as a shift away from Office Commercial products was offset by growth in cloud services. Office 365 Commercial revenue was up 15% and LinkedIn revenue rose 26% to $768m. Operating profits rose 12% to $799m thanks to revenue growth in higher-margin parts of the business.

More Personal Computing saw revenue rise 2% to $270m. Production shutdowns and the deteriorating PC market sent Windows sales to manufacturers lower, but this was offset by growth in Windows Commercial. Search and news advertising revenue was up 15% but gaming revenue fell 7% to $259m as Xbox hardware sales and content and services revenue fell. An 8% increase in operating expenses and a less profitable mix of services sold meant operating profit fell 5% to $254m.

Quarterly free cash flow excluding acquisition costs was $17.8bn, up from $16.3bn. On 30 June, net cash was $55.0bn, down from $72.2bn, primarily reflecting $22bn spent on acquisitions this year.

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 July 2022