Microsoft: Cloud Prospects, Q2 FY22 Guidance Looks Promising

Summary

• Microsoft demonstrates that size is no hindrance to performance.
• Microsoft's next quarter guidance looks promising.
• How shareholders should think about Microsoft Cloud's prospects.
• Microsoft is priced at 36x forward earnings, seriously not expensive for what's at play here.
• I do much more than just articles at Deep Value Returns: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »

4kodiak/iStock Unreleased via Getty Images

Investment Thesis

Microsoft (NASDAQ:MSFT) continues to surpass all expectations, as its top line continues to grow at more than 20% CAGR, and its guidance for the next quarter also looks very promising.

Investors are asked to pay 36x forward earnings for a company that's evidently still a growth company, despite being the biggest company in the world.

For buy and hold investors, that wish to buy right, hold tight and forget, look no further than Microsoft, here's why:

Microsoft's Revenue Growth Rates Accelerate?

Source: author's calculations, **company guidance

Unimaginable as it may seem, Microsoft's top line was up 22% for Q1 2022. Even now, this dinosaur in technology years is still a rapidly growing business. And it's even more attractive when you note that its guidance for the quarter ahead points to nearly 20% CAGR, once again.

Now, consider the following figures, Microsoft's free cash flow during Q1 2022 reached just under $19 billion. Of that free cash flow, more than 60% returned to shareholders via share buyback or dividends.

So what you have is a business that's clearly investing for growth, growing at a rapid clip, with non-GAAP EPS figures up 23% y/y.

(Source)

Why Microsoft Now?

Microsoft put Q1 2022 results showing that the biggest opportunity it continues to face is the cloud. Despite Microsoft Cloud reaching nearly $21 billion in revenues over the past quarter, it succeeded in being up 36% compared with the prior year.

As a reminder, Microsoft Cloud is formerly commercial cloud. Microsoft Cloud revenues come from Azure, Office 365 Commercial, and Office Products to mention a few business units. Its revenues are spread amongst different segments so we don't have a clear operating profit profile for these revenues.

That being said, Microsoft Cloud as a whole is bigger than Amazon's (AMZN) AWS, which reported $16 billion for the same trading period.

What's more, keep in mind that Microsoft Cloud is aimed squarely at enterprises, and does not include any revenues from Microsoft's Consumer cloud services.

Altogether this starts to give investors some scope of the size of Microsoft's cloud exposure. Also, keep in mind that predominantly, Microsoft annuity revenues reached 95%. This provides Microsoft with incredible stability, reliable cash flows, and visibility.

Hence, when investors start to push back that Microsoft is already the biggest company by market cap, I posit to readers, how many cloud companies are out there growing at tens of billions per 90 periods, with 71% gross profit margins and doing so at more than 30% CAGR? Asides from Amazon, I believe that readers will struggle to forward me many names.

To illustrate further, I have a lot of admiration for Alphabet, but as I discussed last week, its Cloud exposure is still some way away from reporting $10 billion of cloud revenues per quarter:

Source: author's work

What's more, consider that 78% of the Fortune 500 use Microsoft's hybrid solutions. In my last Microsoft article I wrote:

[Fortune 500] are companies with the financial resources and technical acumen to demand only the best of the best hybrid cloud. And by far and wide, the bulk of these global enterprises still chose Microsoft's cloud platform.

Needless to say that I stand by that comment. Companies that require peace of mind for their mission-critical work, will seek Microsoft for reliability and the strength of its brand.

No one will ask difficult questions if a company adopts Microsoft for its cloud solutions. Can the same be said if a company adopts a slightly smaller, up-and-coming cloud provider? I doubt it. It's like an insurance policy, for the head of IT, no one will fault the head of IT for going embracing Microsoft's cloud offering. Microsoft's cloud services provide analytics, data integration, and warehousing. It's a one-stop-shop cloud solution for any enterprise.

As the global workforce increasingly works from anywhere, employees need the right tools to ensure that the hybrid work is seamless. Microsoft breaks down IT silos and ensures collaborative efforts don't have added layers of friction.

Now, let's discuss Microsoft's valuation.

Valuation - MSFT Stock Still Attractively Priced

Microsoft is priced at 36x forward earnings. Not sales, but actual earnings. As noted higher in the article, Microsoft is growing its bottom line at more than 20% CAGR. Thus, paying 36x forward earnings for a company that touches nearly every single business somewhere along their productive day doesn't strike me as expensive.

You can think of Microsoft as a toll bridge, where every business passes through, and Microsoft collects a fee along the way.

The Bottom Line

Microsoft continues to report solid bottom-line growth, and yet, despite being the biggest company in the world it's still attractively priced at 36x forward earnings.

Microsoft is incredibly cash flow generative, returns meaningful capital to shareholders, and provides few negative surprises to shareholders.

All that being said, I prefer to deploy my own capital into smaller cap stocks. Good luck and happy investing!

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[slam stocks]

MSFT is a massive conglomerate with multiple dominant businesses. They’re involved in so many activities, the cross selling likely significantly understates their Cloud growth to boost returns in other divisions. It’s highly likely to downplay their market share and quietly continue their substantial growth claiming being Second. Cloud is just beginning to accelerate and often compared to the Railroads. MSFT will be the Central Station HUB. A very strong buy and continuing to add on dips.

[JumboGator2001]

Great article! Great quarter and great ability to grow top and bottomline. It’s still very fairly valued as I think it will rally

[combatcorpsmanVN]

If an investor is worried about MSFT's PE ratio; there's always INTC, XOM, BP, and a variety of "core" stocks selling at PE's lower than their shoe size. If PE is your main parameter, good luck in the above shares or many Utilities.

Who needs a Ferrari anyway?

[No Guilt]

@combatcorpsmanVN

PE PE PE
PE
PE

That’s ONE basic way to look at things

[Shangrila Value]

Good thesis, but I wouldn't call 36x as "seriously not expensive".

[wsoyke]

@Shangrila Value
Considering growth, recurring revenue, M&A, R&D, margins, cloud growth, gaming, shareholder return, the PE doesn't tell the whole story.
Too often "value" investors fail to see the "value" in growing companies. Second level analysis is required here. Where is the puck going? MSFT is firing on all cylinders in every segment, and will continue to do so, probably for decades at least.

[No Guilt]

@Shangrila Value

PE is one side of the equation

So go buy a “cheap” no growth stock.

[Legitimate]

@No Guilt MSFT is my biggest position, but you guys make it sound like this is super easy to invest in considering the 2.5T market cap. The company is a clear winner and as long as Nadella leads it’ll probably keep growing. I can’t call a 2.5T business cheap even with their incredible growth and numbers.

[mok31]

Long time MSFT stockholder, best investment I ever made.
Nadella has been the perfect leader for this terrific company.

[ChuckXX]

I also own MSFT but with $4.9 Trillion Dollars sitting in Money Markets & interest rates still incredibly low there is no place to go with all this money. Now if a person could get 5% in a 10 Year Treasury then all bets are off. That won’t be the case anytime soon.

[Willow Street Investments]

@ChuckXX "there is no place to go with all this money"

Yes there is, value stocks.

[Dividend Ambassador]

@Willow Street Investments Boy, that is where I have been going. During the Pandemic I have put lots of new money into the likes of PRU, CVS, PFE, PM, MRK (all at significantly lower prices than today — not buying at today’s prices) and BMY, BTI, MO, AMGN, ABBV, C, CI, GILD, UNM (at slightly below or slightly above today’s prices — still buying). I also managed to scoop up some AMP and some SNA and PRU (got some around 40 and kept buying into the 70’s) at just MASSIVE discounts during the actual days of the initial Pandemic Panic.

This has actually been a good period for value purchases.

[Willow Street Investments]

@killiondt Bought CVS last year, AOS in 2020, INGR early 2021, VFC several weeks ago and looking for some more GILD if it stays down.

[Willow Street Investments]

I own msft for 25 years and a 36 pe is very expensive...one small stumble and look out below.

[Dividend Ambassador]

@Willow Street Investments I agree. Even 20% growth which is very likely unsustainable for more than a couple to a few years does not justify PE 38. Sorry. I will hold unless things get as insane as they did in 2000 (PE 70).

[Willow Street Investments]

@killiondt I am in it for the income...getting $2000 every 3 months from MSFT.

[Dividend Ambassador]

@Willow Street Investments Yes, $8000 per year is wonderful. Only $500 every 3 months or $2000 per year from MSFT here.