Company Overview: Microsoft Corporation is a technology company. The Company develops, licenses, and supports a range of software products, services and devices. The Company's segments include Productivity and Business Processes, Intelligent Cloud and More Personal Computing. The Company's products include operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; video games, and training and certification of computer system integrators and developers. It also designs, manufactures, and sells devices, including personal computers (PCs), tablets, gaming and entertainment consoles, phones, other intelligent devices, and related accessories, that integrate with its cloud-based offerings. It offers an array of services, including cloud-based solutions that provide customers with software, services, platforms, and content, and it provides solution support and consulting services.
 

MSFT Details

The equity markets seem to be on a downturn with the rising 10-Year Treasury yield as seen in the past few couple of trading days. This has led the stocks, particularly the tech growth stocks that were earlier trading at higher multiples to witness some weakness. Amidst the scenario, Microsoft (NASDAQ:MSFT) with the latest softness looks to be a good buy option while the rates have been higher but MSFT still stands a bit resilient in comparison to many counterparts. The stock trades at a PE multiple of about 28.8x over the trailing twelve months with long term fundamentals shining on growth at the back of cloud expansion strategies. With market weakness at broad level, the stock is now down and quite close to its 100 day moving average ($105), and this gives a buying opportunity. End of October, when the group releases another quarterly update is expected to showcase the momentum witnessed so far. Growth narrative with group’s Azure growing at a rate of above 80% supports the valuation and revenue for the next three years is expected to grow by about 10% per year. The earnings per share projection also look to be around mid-single digit over the next three years and can lead to a growth upside to the prevailing levels in the order of single to early-double digit while EBITDA and operating margins are improving.


Performance Metrics (Source: Company Reports and Thomson Reuters)

Launched Project xCloud: Microsoft Corporation, the developer of a wide range of software products, services and devices has announced a new game streaming service, Project xCloud, which is designed to bring the console’s titles to a number of different platforms. This service is set to provide for cross-platform autonomy to gamers while it brings CPU-heavily titles to PC and mobile devices. The service will be up for public trials sometime next year while MSFT is recruiting various developers to bring content to the service and test it in private beta. This might give competition to the lately announced service by Google, which has launched Project Stream in beta. MSFT has been actively pursuing a cloud gaming service that would allow the users to play Xbox games without an actual console. Project xCloud, is a company-wide push that leverages MSFT’s expertise of a multitude of different teams. It  involves the Microsoft Research division, that is working on everything from quantum computing to AR/VR to genomics, to crack thresholds that probably wouldn’t have been cracked otherwise. Further, it involves the strength of Microsoft’s globe-spanning network of Azure data centers.

Strategic partnership with Singapore based company, Grab: MSFT plans to invest an undisclosed amount into Singapore-based ride-hailing company Grab, which will be a part of a strategic partnership. However, both the companies declined to disclose the amount of the strategic investment. The two companies also plan to collaborate on technology projects in areas such as big data and artificial intelligence. Grab now plans to use a number of Microsoft products, including the Azure cloud computing service. This year, Grab had already raised $2 billion from Toyota and other institutional investors. The company had raised about $6 billion in total funds as of Aug. 2, 2018, and its value is approximately at $11 billion. Further, there are news reports that Japan's SoftBank are closing a deal to invest about $500 million in Grab as part of the latest funding round that is expected to be complete in a few weeks. Additionally, as per the deal between Grab and Microsoft, Grab will work with MSFT to develop new methods to verify passengers and drivers using facial recognition technology with built-in artificial intelligence that is expected to improve the safety and security for users.  Grab plans to use MSFT's data analytics, fraud detection, machine learning and computer vision technologies and services to personalize the user experience. The passengers could also be able to book rides directly through the Microsoft Outlook application. MSFT considers artificial intelligence to be one of its top priorities and investing in AI will remain a focus for the company going forward.

Strategic partnership with Volkswagen: MSFT and Volkswagen have signed a collaboration to develop the 'Volkswagen Automotive Cloud'. This will be one of the largest dedicated automotive industry clouds for all future Volkswagen digital services and mobility offerings. With Microsoft, the company continues its digital transformation into a mobility provider with a fully connected vehicle fleet and the digital ecosystem "Volkswagen We". Further, the Volkswagen Automotive cloud plans to be built from the ground up on top of Microsoft’s Azure cloud and IoT Edge platform as its technology foundation. Initially, Microsoft cloud services including Azure IoT, PowerBI and Skype to create in-car consumer experiences, telematics and productivity solutions will be leveraged under this partnership. Additionally, going forward, the solutions developed through the strategic partnership with MSFT will be rolled out to other Volkswagen Group brands in all regions of the world, which will build the foundation for all customer-centric services of the brands, including the Volkswagen ID. electric family as well as conventionally-powered models. In the future, Volkswagen's fleet of cars will become mobile hubs linked by Microsoft Azure.


Volkswagen Automotive Cloud (Source: Company Reports)

Strong performance in the fourth quarter 2018: MSFT in the fourth quarter of FY 18 has reported the adjusted earnings per share of $1.13, beating the analysts’ estimates for the adjusted earnings per share of $1.08. The company had reported the adjusted revenue growth of 17 percent to $30.09 billion in the fourth quarter of FY 18, beating the analysts’ estimates for revenue of $29.21 billion. Additionally, during the fourth quarter of 2018, operating income rose 30 percent (24 percent in constant currency) and gross margin percentage was 68 percent, ahead of the company’s expectations, up 1 point year over year due to improvement in the More Personal Computing segment, driven by Surface.


Q4 2018 Financial Performance (Source: Company Reports)

Increased the Quarterly Dividend: MSFT has declared a quarterly dividend of $0.46 per share, which is a 4 cents or 9.5 percent increase over the previous quarter’s dividend. The dividend will be payable on December 13, 2018, to shareholders of record on November 15, 2018. The ex-dividend date will be November 14, 2018.

Outlook: For full year 2019 and in line with on-going trend, the earnings may touch over $4 per share and revenue may be over $120 billion, representing year-over-year changes of around 10%. For the first quarter of 2019, MSFT has projected to report earnings of $0.96 per share, which is year-over-year growth of 14.29% and revenue is expected to be of $27.86 billion, up 13.52% from the year-ago period. Meanwhile, MSFT’s cloud computing market segment is big enough to boost the company’s revenue growth for the next three to four years. Meanwhile, for the first quarter of 2019, MSFT expects FX to deliver revenue growth by approximately 1 point and decrease COGS and operating expenses by 1 point, assuming the current rates remain stable. For the commercial business, MSFT expects another strong quarter with commercial unearned revenue down approximately 10 percent sequentially, which is in line with the historical seasonality. Commercial cloud gross margin percentage is expected to improve slightly on a sequential basis in Q1 2019. There is expectation of sequential growth in capital expenditures in the first quarter as the company continues to support growing, global customer demand. For Productivity and Business Processes, the revenue in Q1 2019 is expected to be between $9.25 and $9.45 billion on the back of double digit growth in Office Commercial and Dynamics.

LinkedIn revenue growth is expected to remain high due to a stronger prior year comparable. In Intelligent Cloud, for Q1 2019, the company expects revenue to be in the range of $8.15 and $8.35 billion. Azure revenue growth is expected to reflect a balance of continued strength in the IaaS and PaaS consumption-based services and a moderating rate of growth in the per-user services. In More Personal Computing, for Q1 2019, the company expects revenue to be in the range of $9.95 to $10.25 billion. In OEM Pro, MSFT expects revenue growth in line with the commercial PC market for the first quarter of 2019 and in OEM non-Pro, the company expects similar dynamics as posted in the fourth quarter of 2018. In Surface, the company expects strong performance from the company’s latest editions, that include the new Surface Go, to drive growth similar to corresponding quarter (Q1) of the prior year. Search ex-TAC is expected to deliver mid-teens growth in the first quarter of 2019 with consistent execution against rate and volume growth opportunities. Further, for the first quarter of 2019, in Gaming, the company expects mid-teens revenue growth due to continued strong user engagement on the platform. However, the software and services growth rate is expected to moderate due to strong third-party titles launched a year ago. Meanwhile, for the first quarter of 2019, COGS are expected to be in the range of $9.5 to $9.7 billion and operating expenses to be between $9.2 and $9.3 billion. For Q1 2019, other income and expense are expected to be approximately negative $100 million and the effective tax rate to be slightly lower than the full year rate due to the volume of equity vests that take place during the first quarter.

Industry Outlook: As per market estimates, the gaming industry is expected to generate $138 billion in revenue this year, from 2.3 billion players. For the first time, more than half of that money will be coming from mobile games. As per MSFT, the cloud computing market alone is expected to grow from $285 billion last year to $411 billion by 2020. The segment is big enough to drive the company’s revenue growth for the next three to four years.

Stock Recommendation: MSFT demonstrates a good upside given the developments, strong product base and financial projections. The stock is trading at a price of $106.16, and has support at $105.3 level and resistance at $115.6. Crossing over the resistance level can lead to a breakout while the stock price has already fallen lately owing to broad-level market weakness and is still above the support level. The weakness in stock price offers a good investing opportunity at the moment. We give a “Buy” recommendation on the stock at the current price of $ 106.16.
 

MSFT Daily Chart (Source: Thomson Reuters)

 
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