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Microsoft (MSFT) Looks Strong In The Long Term Because Of Strong Dividend Yield And Cash Flows

|Includes: Microsoft Corporation (MSFT)
Summary
  • Strong revenue gains in 2014 will lead Microsoft well into the future.
  • High dividend yield will create a strong income stream for investors.
  • Many risks are being tackled by MSFT at the time, but a strong management team will set up the company for success.

Microsoft (NASDAQ:MSFT)

Executive Profile

Revenue guidance for the year was down from analyst consensus, but revenue was still up 18% y/y. Microsoft still has a fortress balance sheet with 85B in cash that is continually being returned to shareholders. MSFT holds 90% of the operating system market, but with most expansion still to be had in the developing world, these lower price points should hurt future growth. The company does have a couple of macro outlook risks, but with a new CEO that has been grown in the business, they are in good hands. This company remains a strong investment in the long term because of a high dividend yield (3.3%) and the abundance of cash on hand that will lead to future growth through acquisitions or research and development.

Business Profile

Microsoft makes money primarily through the sale of business productivity and operating system software. Microsoft's business productivity software suite, known as MS Office, is used for word processing, spreadsheet preparation, presentations and email. MS Office is sold primarily to businesses worldwide. Microsoft's operating system software, known as Windows, is sold primarily to PC manufacturers (such as Dell, HP, Acer) which sell Windows-based PCs to consumers and businesses.

Financial Strength (FYE end June 30th)

Revenue

- 23.38B up 18% y/y, Gross income at 15.79B up 10% y/y

Operating Income

- 6.48B up 7% y/y

Revenue Guidance

- 21.2B below consensus of 23B

Balance Sheet

- Current ratio of 3.8 with 85B in free cash

Moat Trend

· While Microsoft still holds approx.90% of the global PC operating system market, continued growth in emerging markets would weigh on Windows operating margins due to lower price points. Analysts believe the Windows business has a negative moat trend as increased competition from alternative operating systems and competing PC devices and smartphones continue to erode Windows' market

· Microsoft continues to expand its database and server market share as it moves up the value chain through increasingly robust feature upgrades and hence the moat trend for the wide-moat server and tools business is stable

· Analysts expect the already strong commercial software business to continue gaining share in a growing market

· Microsoft's devices and services reorganization provides a more cohesive strategy to deliver services in world changing to cloud and mobility from PC and server

· The Azure platform is developing into a significant growth driver alongside the company's other cash cows

Few Risks

  • Microsoft faces threats to its flagship Windows business on multiple fronts and has been playing catch-up in online search, mobile devices, and the cloud. Companies like Apple and Google currently dominate the mobile and tablet computing OS markets and have made inroads into the PC operating system market share

· Weak macro impacting global PC sales and PC cannibalization by tablets

· Windows 8 release and Nokia integration falls behind expectations

· Online Services and strength in Xbox One likely to drag on margins

Management

  • Satya Nadella is the third CEO in Microsoft's history. Previously, he headed the firm's cloud business, Azure, and has served in various other capacities over his 20-plus years with the firm, including with the former server and tools business, Bing search, and Office
  • Analysts believe Nadella was a safe choice for the top slot and brings engineering, sales, and finance experience to the post. His extensive history with the enterprise side of the firm bodes well as he was previously running Azure, widely believed to be the keystone for Microsoft's future
  • While he has been on the job just a short time, analysts view his moves to leave the "Windows First" strategy in the past an important strategic decision

Investment Rationale

  • In the past, Microsoft has not hesitated to make large acquisitions in an attempt to regain lost ground (aQuantive, Skype, and more recently Nokia)
  • With cash on the balance sheet totaling more than $85bn, the firm has the capabilities to make additional large acquisitions or return capital to shareholders
  • MSFT currently trades at $45.17 (price as on 25-Aug, P/E(ttm) 16.8) with 52 week range of $30.9-$45.7 and has an attractive dividend yield at ~3.3% and looks undervalued over medium to long-term given-

o Prospect of solid enterprise business and strong expense management which can lead to sustained EPS growth

o Stronger growth potential and greater scale in Microsoft's commercial cloud business

o Aggressive return of cash in the form of share repurchases or dividends and traction in some of the consumer and devices businesses e.g. mobile can enhance stock performance

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.