Microsoft Corporation delivered a strong Q2 earnings with the stock reaching new all-time highs. Is MSFT stock a buy now?
Redmond, Washington-based Microsoft Corporation (NASDAQ:MSFT) reported its Q2 2017 earnings on January 26th, delivering a third consecutive earnings beat. In fact, the software giant has missed earnings estimates only once in the last 10 quarters, while beating on the revenue front in all. Microsoft reported an EPS of $0.83 on revenues of $26.07B, topping analysts estimates for EPS of $0.78 on revenues of $25.28B. The best part is that Microsoft has continued the trend of revenue growth, though marginal, in Q2 as well. The tech behemoth had returned to revenue growth in Q1 2017 after five previous quarters of negative revenue growth. Clearly, an indication that Microsoft is slowly making the much-anticipated turnaround. MSFT stock was up 2.35% after earnings release and has gained almost 5% YTD hinting at a distinct sense of bullish sentiment. So, should you buy MSFT stock now? Let's take a closer look.
Microsoft posted strong Q2 earnings with EPS and revenue growth of 9.2% and 2.2% respectively, on a YoY basis. Net income also registered decent growth increasing 6% to $6.5B from $6.1B in the year-ago quarter. However, the highlight was free cash flows growing by 20.5% YoY to $4.3B. All these factors propelled MSFT stock to its all-time highs. In fact, Microsoft crossed a market cap of $500B after 17 years, as reported by Reuters, due to sustained bullish sentiment and a strong earnings report.
Cloud Driving Microsoft's Growth Engine
In the December quarter, for the first time, Microsoft’s commercial cloud run rate exceeded $14B. Microsoft's Productivity and Business Processes segment which consists of Office commercial and consumer products, Dynamics products and cloud services grew 10% YoY to $7.4B. Server products, cloud services, enterprise services and Azure contributed to the company's Intelligent Cloud segment to post $6.9B in revenue, growing 8% YoY. Azure remains to be the star performer with revenues growing 93% YoY while Office 365 commercial revenue registered strong 49% growth. In the latest quarter alone, Office 365 consumer subscribers jumped by 1M to reach 24.9M.
Microsoft is the second biggest player in the public cloud market after Amazon's (NASDAQ:AMZN) AWS and if you go by AWS' success, Microsoft has a big opportunity ahead of it. While referring to Azure during the earnings call, Satya Nadella, CEO, Microsoft stated:
"Across industries, we continue to see strong customer demand for our differentiated cloud solutions. Azure revenue grew 95% in constant currency this quarter. Azure premium revenue grew triple digits for the 10th consecutive quarter, and more than three out of four Azure customers are using Premium services."
With so much potential in Azure, Microsoft is well positioned to ride the cloud growth wave ahead. It also seems Microsoft is well on course to achieve CEO Satya Nadella's April 2015 pledge of $20B in annualized cloud revenue by 2018.
LinkedIn And Other Segments
The Q2 earnings came after Microsoft completed the $26B LinkedIn acquisition on December 8th. Technically Q2 earnings included few weeks of LinkedIn results as well, but Microsoft has broken out the LinkedIn performance to facilitate comparisons. The financials of LinkedIn for Q2 can be seen in the image below which brought in $228M revenue. A lot is expected from the LinkedIn acquisition. Investors would be very much interested in the LinkedIn numbers in the future quarters following Microsoft's multi-billion dollar investment.
source: Company earnings slide
Microsoft's More Personal Computing segment revenues are down 5% YoY to $11.8B with declining worldwide PC sales continuing to be a headwind. Though Microsoft stated that its Xbox live users were up 15% from the year-ago quarter to reach a record 55M, it's gaming revenues were down by 3%. The upcoming opportunities in VR/AR could give a major push to Microsoft's gaming and PC business. Microsoft's Surface Lineup remains a bright spot and it is profitable too. Microsoft Surface Pro 5 launch is eagerly awaited this year and its success could significantly shore up the $4.3 billion business.
The Q2 results have shown Microsoft's resurgence under Satya Nadella. MSFT stock reaching new all time high is one clear indicator. Recently, Citi, which was a noted MSFT bear, also upgraded MSFT stock to a 'Neutral' rating from an earlier 'Sell' rating. This highlights renewed optimism among analysts about Microsoft and its transition.
Putting It All Together
MSFT stock is trading at a steep earnings multiple of 31 compared to the industry average of 22. At this high valuation, MSFT stock could still be a bargain for investors if Microsoft continues to grow its cloud business which looks very promising, for now. Microsoft is definitely not a hyper-growth investment opportunity but it offers what very few companies at present can offer; increasing dividends, regular stock buybacks and an ability to consistently deliver value in the long-term. The renewed optimism in the market about MSFT stock is reflected in its stock price. Microsoft stock is a relatively safe long-term bet, even at these levels, after the strong Q2 performance.
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