Microsoft Earnings Preview: Transitioning From Deep Value, Capital Allocation Story To Growth Stock ?

| About: Microsoft Corporation (MSFT)

Summary

MSFT (the stock) was a stalwart during this recent 8% correction.

The price action is telling me Satya Nadella still getting the benefit of the doubt.

MSFT's Cloud traction more critical than ever.

Microsoft (NASDAQ:MSFT) reports its fiscal Q1 '15 earnings after the closing bell on Thursday, October 23rd, 2014.

Consensus analyst expectations are looking for $0.49 in earnings per share (NYSEARCA:EPS) on $22 billion in revenue for expected year-over-year growth of -21% and +19% respectively.

The numbers (I think) are being impacted by the Nokia acquisition, since in Q4 '14 which was the quarter ended June 30, saw EPS reduced by $0.08 due to the closing of the Nokia acquisition.

Obviously this is a tough compare on EPS from September '13, but the overall expectations around the business haven't changed much, with a decent Enterprise Market and a soft Consumer expected.

It is anecdotal, but I have heard positive comments about Surface 3.

2015 guidance coming out of the July '14 earnings call was pretty tame: current consensus is expecting 14% y/y revenue growth and 3% EPS growth, which hasn't changed much in the last 3 months.

Here is the consensus EPS and revenue trends for MSFT:

                       

Microsoft

                     
 

EPS Consensus Trends

     

Revenue Consensus Trends

       
 

fy

fy

y/y gro

fy

y/y gro

fy

fy

y/y gro

fy

y/y gro

 
 

2015

2016

est

2017

est

2015 rev

2016 rev

est

2017 rev

est

 

current (10/21/14)

$2.72

$3.18

17%

$3.39

7%

$99,086

$105,973

7%

$112,128

6%

 

sept '14

$2.71

$3.20

18%

$3.37

5%

$99,136

$105,569

6%

$111,838

6%

 

Aug '14

$2.72

$3.19

17%

$3.36

5%

$99,166

$105,512

6%

$112,067

6%

 

July '14

$2.73

$3.19

17%

$3.38

6%

$99,275

$105,573

6%

$111,927

6%

 

Apr '14

$2.88

$3.18

10%

   

$101,417

$109,552

8%

$95,068

n/a

 

Jan '14

$2.91

$3.19

10%

   

$89,824

$96,060

7%

$96,588

n/a

 

Oct '13

$2.92

$3.14

8%

   

$89,071

$93,499

5%

$92,563

-1%

 

# of est's

24

28

 

8

 

31

26

 

9

   

* Source: ThomsonReuters current and historical consensus estimates

             

* MSFT fiscal year ends 6/30

                   
                       
                       

The numbers don't reflect much other than the Nokia acquisition impacted revenues and it is actually fiscal 2016 (starts July 1, 2015) where MSFT is looking for above-average growth.

In Q4 '14, Cloud revenues were roughly $4.5 billion or roughly 4.5% - 5% of the consensus '15 revenue estimate. I do think the rate of growth of the Cloud segment and its traction, will be important over the next few quarters.

Valuation: MSFT consensus over the next 3 years is expecting 9% on both EPS and revenue growth over the next 3 years, through fiscal '17. At 17(x) earnings, the stock looks fairly valued on a p.e basis, depending on whether MSFT management can generate better-than the 3% consensus in fiscal '15.

On a cash-flow basis, MSFT is trading at 9(x) cash-flow ex-cash, and 11(x) free-cash-flow ex-cash.

On an "operating-cash-flow-per-share" (OCFPS) basis, MSFT is trading at 11(x) the $3.85 4-quarter trailing OCFPS as of June 30.

My own opinion on the stock is that it is transitioning from a potential capital allocation, value stock where the cash balance of $86 billion and the substantial cash-flow (despite the overseas domicile) captivated value investors, to a focus on operating metrics, and a potentially-emerging mid-teens growth stock.

Here is what we will be looking for on Thursday's call:

1.) Cloud revenue growth;

2.) Expense reductions around Nokia and headcount ? The Nokia metrics in q4 '14 supposedly weren't that great;

3.) Is there anything MSFT can do with the expected $90 billion in cash on the balance sheet ? This cash balance has been growing $3 - $4 billion each quarter, forever.

4.) Surface 3 - how is it being received and does it matter ?

Let's face it: some readers might disagree, but "reinventing" a software company is easier to do than say, reinventing IBM, but it is easier to do and the cycles are shorter.

Some think that MSFT is nearing a time where it needs to split the company ala Hewlett-Packard (NYSE:HPQ), but I think Satya will be given more time, like Meg Whitman was given.

There is still an outside chance investors see a one-time dividend (very slim) or other "capital allocation" event, but those odds have diminished as Satya seems to have driven a renewed focus on earnings and revenue growth, and driving growth around the core PC business.

Technically, the stock's relative strength during the recent 8% - 9% peak-to-trough correction in the SP 500, was a strong positive for us.

I wont say that this earnings report will drive the stock above the 52-week high of $47.57.

We own a decent size position for clients in the portfolio and have added to the stock in the last few months.

Positive momentum seems to be building. We'll stay with it until the numbers tell us otherwise.

Disclosure: The author is long MSFT, HPQ, IBM.

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.

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