Microsoft Earnings Preview: More Fully Valued Today, But Satya Wasting No Time

Jul.21.14 | About: Microsoft Corporation (MSFT)

Summary

Looking at the numbers, revenue versus EPS growth, the job cuts make sense.

Revenue estimate and revisions remain positive.

Stock is far less undervalued today.

Microsoft (NASDAQ:MSFT) reports their fiscal Q4 '14 earnings after the bell on Tuesday, July 22nd, 2014.

MSFT's analyst consensus, per Thomson Reuters, is expected to print $0.60 in earnings per share (EPS) on $23 billion in revenues, for expected year-over-year (y/y) growth of -9% and +16%, respectively.

Since early July, forward EPS estimates have been reduced by about a penny across the forward quarters while revenue estimates have been raised slightly for 2015.

If Q4 '14 consensus comes in as expected, full year EPS and revenue growth for fiscal 2014 will have grown 2% and 11% respectively.

Full year fiscal 2015 expectations are for EPS and revenue growth of 6% and 18% respectively.

When you see these forward metrics, you can see why Satya Nadella feels the need to reduce 18,000 jobs.

MSFT is unable to leverage what is expected to be pretty decent revenue growth in 2015, with EPS growth coming in far short of revenue.

Here is how the numbers fall out given current consensus:

Microsoft

EPS Consensus Trends

Revenue Consensus Trends

n/a

fy

fy

y/y gro

fy

y/y gro

fy

fy

y/y gro

fy

y/y gro

n/a

2014

2015

est

2016

est

2014 rev

2015 rev

est

2016

est

current (7/15/14)

$2.69

$2.85

6%

$3.12

9%

$86,549

$102,437

18%

$106,968

4%

Jun '14

$2.70

$2.87

6%

$3.15

10%

$86,380

$101,744

18%

$107,036

5%

May '14

$2.69

$2.87

7%

$3.15

10%

$86,231

$100,414

16%

$107,660

7%

Apr '14

$2.69

$2.88

7%

$3.19

11%

$86,495

$101,417

17%

$109,552

8%

Jan '14

$2.70

$2.90

7%

$3.19

10%

$84,450

$89,824

6%

$96,060

7%

Oct '13

$2.67

$2.92

9%

$3.14

8%

$83,442

$89,071

7%

$93,499

5%

Jul '13

$2.77

$3.03

9%

$3.34

10%

$82,277

$87,622

6%

$92,325

5%

Apr '13

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

Jan '13

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

Dec '12

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

# of est's

23

24

13

12

12

5

Click to enlarge

* Source: ThomsonReuters current and historical consensus estimates

* MSFT reports on fiscal year ended June 30

Fiscal '15 looks pretty solid, expect EPS growth falls far short of revenue growth.

Having never been a "technologist" so to speak, and never understanding the implications of that strategic move, or this acquisition, it did feel like the recent announcement between Apple (NASDAQ:AAPL) and IBM (NYSE:IBM) was a direct assault on MSFT's enterprise position, and a way for Apple to make further inroads into the personal computer/tablet utilization across the enterprise.

Some might think that is completely inaccurate, and we'd welcome the differing opinions.

Microsoft really started to outperform in April, 2013 when it was announced that ValueAct had taken a position in the stock, and that they were also seeking position on MSFT's Board.

Like a lot of the old large-cap tech leaders of the 1990s, MSFT is now transitioning from a value stock, with a lot of cash, and robust cash-flow, to a company that needs to generate revenue growth, and bring itself into the 21st century in terms of technological relevance.

From a strictly personal perspective, and as an anecdotal example, as a small advisor I recently replaced my Dell desktop with a Hewlett-Packard (NYSE:HPQ) desktop and upgraded to Windows 8.1 from Windows 7.

My technology consultant read me the riot act for adopting Win 8.1 without talking to her first, and a number of my vendors and research providers have commented that they aren't really wild about 8.1. (Interesting that last week MSFT announced they would stop supporting Win 7 in January '15. It does seem like they are now trying to drive conversion to the new operating system faster than what transpired in the 2000s.)

At $44 per share, MSFT seems fully valued at 9(x) and 12(x) cash-flow and free-cash-flow ex-cash, and after its 15 month run from $26 to $44 since ValueAct and Satya started to transform the O/S giant into a 21st century major technology player.

8 quarters ago, MSFT had a 12% free-cash-flow yield, today it has a more reasonable but still attractive 6% free-cash-flow yield.

Our internal model puts a perceived intrinsic value estimate on MSFT of $43 per share, while Morningstar's intrinsic value estimate is $42.

The three year average EPS growth rate of 6% (fiscal '14, '15 and '16) is probably the next catalyst to the stock, if Satya and the Board want to drive earnings growth, to match the pretty decent revenue growth MSFT is expected to see over the next 3 years of 11%.

If the trend still holds, MSFT has been adding $4 - $5 billion in cash per quarter, to the balance sheet consistently the last 10 years. When the financial results are released Tuesday night, it looks like the cash and investments on MSFT's balance sheet will likely be $92 - $93 billion or $8 - $9 per share.

Unfortunately most of the cash is still held overseas, and thus MSFT has been adding long-term debt the last 2 years, presumably to help the dividend and share repo program.

If Congress would ever cure the tax inversion issue, maybe they will do something about the cash repatriation too.

MSFT would be a huge beneficiary of tax relief on overseas cash repatriation.

MSFT is far more fully-valued today in July, 2014, than in April, 2013, but we are going to maintain our position and give Satya Nadella the benefit of the doubt from an operational perspective.

Satya is taking decisive action quickly. Let's see how 2015 guidance shakes out.

Disclosure: The author is long MSFT, AAPL, IBM, HPQ. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.