It has been a tough year for equities across the board, including software titan Microsoft (NASDAQ:MSFT). The stock has lost about a fifth of its value this year prior to reporting fiscal third quarter ended March 31st on Tuesday (April 26th) after the bell. But a solid sales and earnings beat across the board continues to underscore Microsoft's market leadership in cloud-based software solutions and related hardware despite a cloudy macroeconomic outlook that has dampened consumer sentiment and spooked investors this year. The reassuring results have inadvertently driven a solid rally for the stock, supporting gains of more than 4% in extended trading Tuesday and increasing the likelihood of ending in the green by the end of Wednesday's regular session.
General outperformance across the business has compensated for investors' aversion of risky assets like high-growth tech stocks amidst a potential economic slowdown in the near-term. Commercial demand, especially for cloud-based services provided by Azure as well as Office 365, has remained robust. The bullish commercial demand environment has continued to provide partial insulation for Microsoft from any "consumer slowdown", assuaging investors' monthslong fears that the increasingly complex macroeconomic environment might result in a pullback in corporate IT budgets and backfire on the business' growth outlook. In fact, industry peers including Google and IBM have reported strong cloud sales during the calendar first quarter, indicating "healthy demand for corporate software", which makes favourable tailwinds for Microsoft.
The company's software-heavy business has also helped it dodge much of the supply chain snarls that protracted pandemic disruptions and the Russia-Ukraine war have threatened to worsen. Even Microsoft's product sales have regained some footing during the fiscal third quarter after succumbing to supply shortages last year. Xbox market share has continued to expand for the second consecutive quarter and is currently the leading "next gen console" across North America and Western Europe, while Surface sales continue to be buoyed by strength from the commercial sector. Although Microsoft has warned that "supply chain constraints could become more impactful" to its product sales performance if the recent pandemic-related lockdowns in China extend into May, a concern that has been echoed by other domestic corporate peers like electric vehicle upstart XPeng (NYSE: XPEV) and technology giant Huawei, the company's continued prudence in building hardware inventory as observed in frontloaded supplier payments is expected to help it offset some of the "uncertainty in the supply chain".
Microsoft's steadfast market leadership in providing critical software to both the commercial and direct-to-consumer markets, alongside robust momentum with Azure in addition to other growth drivers make it an attractive long-term investment pick still. Especially under the current market climate, the inflation-resistant nature of Microsoft's business model, paired with its robust balance sheet, attractive shareholder returns, and sustained growth across all segments makes it one of the safest picks in the current risk-off environment for equities.
Microsoft's consolidated revenues grew 18% y/y to $49.4 billion in the fiscal third quarter, beating both consensus estimates and its previously provided guidance of $49 billion and $49.3 billion (upper range guidance), respectively:
Based on the company's latest financial results, its bullish thesis remains fixated on its continued strength in Azure cloud-computing and critical cloud-based productivity software like Office 365. During the fiscal third quarter, Microsoft saw the "number of $100+ million Azure deals more than double year-over-year", which continues to corroborate "broad-based acceleration in [cloud] consumption". A closer scrutiny of Microsoft's Azure performance in recent periods would also reveal that the world's second largest public cloud service provider has grown at an impressive rate of 46% to 50% y/y in each of the past seven quarters, becoming a core revenue driver for the company. In addition to Azure, Microsoft also continues to benefit from robust commercial demand for its cloud-based productivity solutions like Office 365 / Microsoft 365 / Dynamics 365 despite macroeconomic uncertainties ahead.
Building a digital fabric remains a critical mission for the commercial sector in order to ensure "improved productivity in the inflationary environment", meaning IT spending on migrating workloads to the cloud and other digital transformation projects will remain strong. Specifically, tech spending contribution to GDP growth is expected to double by 2030, as software becomes a key "deflationary force" going forward by driving "better economic outcomes". This makes strong tailwinds for Microsoft's growth prospects over the longer-term, especially considering only 11% of the global corporate landscape currently feels confident that their legacy business models will be "economically viable through 2023" and another 64% raising the need to step up on digitization plans to remain financially and operationally competitive. More than half of the corporate scene have expressed that they would rather "tighten the belt" in other parts of the business than to miss out on digital transformation, which is considered a strategic investment in differentiating themselves from competitors, while also enabling cost efficiencies.
Microsoft's recent acquisition of Nuance, a "leader in conversational AI and ambient intelligence", will also complement the company's continued build-out of its cloud-computing capabilities. The consolidation of Nuance will accelerate Microsoft's efforts in enabling customers with "security-focused, cloud-based solutions infused with powerful, vertically optimized AI", which are crucial to improving productivity and delivering better economic outcomes. The integration of Nuance into Microsoft's roster of cloud-based solutions is expected to drive further capitalization of fast-growing digitization opportunities ahead, especially as it enables cross-selling of new and improved solutions to existing customers, while also supporting penetration of new markets.
Adjusting our previous forecast for Microsoft's actual Q3'22 results, as well as its Q4'22 guidance based on recent developments specific to its cloud-computing aspirations, we are projecting total revenues of $199.3 billion (+19% y/y) for full fiscal year 2022. The topline is expected to further advance at a compounded annual growth rate ("CAGR") of 10.8% towards annual revenues of $378.4 billion by fiscal 2027, which is consistent with Microsoft's continued outperformance across the board, buoyed by unwavering market leadership in critical cloud-based software ahead of an accelerating digitization cycle in coming years.
Consistent with the foregoing analysis, much of Microsoft's performance will continue to rest on its cloud-based service sales, alongside other revenue growth drivers such as the sale of personal computing and gaming devices. Intelligent Cloud revenues are expected to expand at a CAGR of 15.9% from $75.6 billion by the end of fiscal 2022 towards $190.9 billion by fiscal 2027, and represent a greater portion of the company's consolidated sales mix over the longer-term. Productivity and Business Processes segment sales, which captures anticipated expansion of commercial demand for Office and Dynamics solutions, are expected to advance at a CAGR of 8.9% from $63.5 billion by the end of fiscal 2022 towards $109.5 billion by fiscal 2027. Meanwhile, More Personal Compute sales are expected to remain on a trajectory of modest growth at a 4.3% CAGR through the forecast period to reflect a softening Windows and device upgrade cycle.
As Microsoft's corporate strategy continues to encourage greater migration towards higher-margin software and service sales, the company's cost structure is expected to benefit from continued mild improvements over the longer-term, especially as cloud-computing programs continue to scale. Related income is expected to expand from $73.5 billion by the end of fiscal 2022 towards $142.1 billion by fiscal 2027.
Our price target for Microsoft remains in the mid-$300 level (~$350) despite the near-term macroeconomic overhang on growth tech stocks and equities in general. We expect upside potential of more than 20%, with the bulk of anticipated momentum returning in the second half of the year and through early 2023, based on the stock's last traded share price of $283.22 on April 27th.
The price target is derived using the discounted cash flows ("DCF") valuation approach, drawing on the projected cash flow streams in accordance with our fundamental forecast analyzed in earlier sections. An exit multiple of 18.6x (EV/EBITDA) is applied, which compares to the +20x that Microsoft is currently trading at, to reflect Microsoft's continued revenue growth above GDP from CY/2026 and beyond. A WACC of 9% is also applied to discount the projected cash flows, which reflects Microsoft's current capital structure, as well as its low risk profile considering the consolidated business' ability to generate robust liquidity from day-to-day operations.
Microsoft's stock remains an attractive long-term investment pick, especially under the current market climate, considering its strong balance sheet and robust growth profile still. The solid fiscal third quarter results, paired with a fiscal fourth quarter guidance beat across the board have also "put investors' macroeconomic worries to bed" when it comes to Microsoft.
The bullish environment surrounding cloud-based software - a market in which Microsoft continues to dominate - also makes strong tailwinds for the company's fast-expanding Azure and internet subscription-based Office solutions. The accelerating digitization cycle in coming years highlight Microsoft's massive growth trajectory as it continues to expand and improve its product roadmap, while also maintaining supreme customer satisfaction to ensure success of its recurring revenue SaaS business model. The critical role of Microsoft's offerings in both the corporate and consumer digital fabric will continue to underscore solid, sustained growth over the longer-term, providing for robust valuation prospects ahead.
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