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Microsoft (NASDAQ:MSFT) issued a guidance revision Thursday for both its top- and bottom-line, citing stronger-than-expected FX headwinds amidst a surging U.S. dollar. The revision comes on the heels of a similar sales outlook adjustment by software peer Salesforce (CRM) earlier this week, which cited a $600 million negative FX impact on its revenues for the current fiscal year. And more can be expected on the way, including technology giants like Amazon (AMZN), Apple (AAPL), Meta Platforms (FB), and Google (GOOG/GOOGL), which all generate a meaningful portion of sales overseas.
However, a resilient demand environment buoyed by robust secular tailwinds has largely overshadowed such international risks. Despite a looming economic recession, Microsoft has yet to see demand slow, citing that "IT spend would not be the first to see budget cuts" as digital transformation remains a strategic investment area across the corporate sector. Our view is that Microsoft remains a core long-term software investment, underpinned by its market leadership in a wide array of critical software categories and robust growth trajectory, balanced product portfolio and continued margin expansion.
The company decreased its fiscal fourth quarter revenue guidance from a range of $52.4 billion (+14%y/y; % +6 q/q) to $53.2 billion (+15% y/y; +8% q/q), to $51.94 billion (+13% y/y; +5% q/q) to $52.74 billion (+14% y/y; +7% q/q), with the difference fully attributable to additional FX headwinds anticipated through the rest of June. Margins have also been trimmed, with gross profit expected to come in at $35.45 billion to $36.05 billion (vs. previous guidance $35.80 billion to $36.40 billion), and operating income $20.6 billion to $21.3 billion (vs. previous guidance $20.9 billion to $21.6 billion). As a result, the fiscal fourth quarter earnings outlook has been revised from $2.28 to $2.35 per share, down to $2.24 to $2.32 per share, which falls slightly short from consensus estimates of $2.33 per share.
However, Microsoft's latest downward revision to its revenue and margins due to the FX overhang is not expected to result in a material change to its valuation outlook. Adjusting our previous financial forecast for Microsoft for the latest outlook revisions, as well as expectations for further FX headwinds through the calendar year (Microsoft has ~50% revenue exposure overseas), the company is estimated to maintain long-term revenue growth at a 10.0% compounded annual growth rate ("CAGR") still. Specifically, revenues are expected to total $198.7 billion (+18% y/y) by the end of the current fiscal year ending June 30th, with further expansion towards $357.4 billion by fiscal 2027. Higher-margin Intelligent Cloud sales will remain the core powerhouse for growth and continue to represent a higher mix of consolidated revenues over coming years with accelerated deployment of digital investments across the corporate sector.
Meanwhile, signs of softening PC market will likely contribute to a moderated pace of growth across More Personal Computing sales, which we anticipate to be in the low single-digits over the forecast period. Productivity and Business Processes revenue, which include Office and Dynamics sales, are estimated to remain a substantial contributor to consolidated growth at an approximately 9% CAGR through fiscal 2027.
Microsoft Revenue Forecast (Author)
Taking into consideration the near-term macro impacts to business, including FX headwinds, the company is expected to generate net income of $73.3 billion by the end of fiscal 2022 (+20% y/y). With additional consideration of the increasing shift to higher-margin Intelligent Cloud sales over the forecast period, as well as management's discipline in balancing revenue growth with sustained margin expansion, Microsoft's net income is expected to further advance towards $134.2 billion by fiscal 2027.
Microsoft Financial Forecast (Author)
On the valuations front, the latest FX headwinds are not expected to materially alter the Microsoft stock's outlook. Despite the currently volatile macroeconomic environment, the company's fundamental runway remains strong. Microsoft continues to show substantial resilience against the potential recession as corporate spending on core digital transformation categories like cloud migration and collaboration/productivity software adoption remain robust over coming years.
Microsoft Valuation Analysis (Author)
As such, we are maintaining our price target for the Microsoft stock in the mid-$300 level (~$340) despite the recent FX impacts, as well as the broader near-term macroeconomic overhang on growth tech stocks and equities in general. This would represent upside potential of close to 25% based on the stock's last traded share price of $274.58 on June 2nd.
Microsoft Valuation Analysis (Author)
Microsoft Sensitivity Analysis (Author)
Market leadership in key software segments. Microsoft benefits from large moat created by its market leadership across key software segments spanning cloud-computing and security services to collaboration and productivity software. This prowess bodes well with ongoing secular tailwinds buoyed by an accelerating multi-year investment cycle on digital transformation across the corporate sector.
With proven expertise across core software requirements needed to remain economically and operationally competitive in the "digital-first" world, Microsoft is uniquely positioned to capitalize on related growth opportunities given its market leadership and "strong value proposition through effective bundling" of services offered. Echoing Microsoft CEO Satya Nadella, tech spending's contribution to GDP growth is expected to double by 2030, as software becomes a key "deflationary force" going forward by driving "better economic outcomes". The trends, paired with Microsoft's market leadership across key software segments, underscore the favourable impact anticipated on Microsoft's longer-term fundamentals.
Robust fundamental performance. Microsoft has largely defied the law of large numbers, as it continues to maintain strong double-digit revenue growth in recent years. The company's consolidated revenues expanded at a 15% CAGR over the past three reporting fiscal years, primarily driven by organic growth across core businesses that count Office 365, Azure, and gaming. As discussed in earlier sections, our forecast estimates continued top-line growth at a 10% CAGR through fiscal 2027, buoyed by increased penetration into cloud opportunities.
The bullish commercial demand environment for cloud-computing solutions has continued to provide partial insulation for Microsoft from any "consumer slowdown", assuaging investors' month-long fears that the increasingly complex macroeconomic environment might result in a pullback in corporate IT budgets and backfire on the business' growth outlook. During the fiscal third quarter, Microsoft saw the "number of $100+ million Azure deals more than double year-over-year", which underscores "broad-based acceleration in [cloud] consumption". And momentum is expected to persist for the segment, benefiting from both new cloud customers looking into a transition away from legacy on-premise IT infrastructures, as well as matured cloud customers looking to bolster their IT capabilities through expanded adoption of Microsoft's Azure-based data offerings (e.g., Synapse, Purview, Azure SQL Server).
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. Collaboration app Teams is also gaining uptake momentum, especially across emerging markets and small and medium enterprises ("SMEs"), in addition to large corporations, to support the post-pandemic era work-from-home norm. Commercial take rate of Office 365 has accumulated to almost 350 million seats as of mid-May, courtesy of additional penetration into peripheral opportunities across smaller-scale business operations.
The rise in demand for security in cloud-based collaborative and productivity tools from the commercial sector has also continued to underpin success for the company's latest Microsoft 365 E5 offering. With a focus on enhancing overall security, compliance, voice and analytic capabilities, the E5 suite is encouraging a flurry of upgrades from existing customers of the preceding E3 suite.
Multiple growth drivers. Microsoft benefits from a diverse growth profile composed of a wide array of core software offerings spanning cloud-computing, security, collaboration and productivity, hyper-automation solutions, and more. The company is uniquely positioned to benefit from growth opportunities arising from key software segments as the consolidation of enterprise IT spend continues to accelerate:
Sustained margin expansion. Balancing revenue growth with margin expansion through disciplined execution of day-to-day operational requirements and investment opportunities remains a priority for Microsoft. The company's gross margin has steadily paced towards 70% in recent quarters, while the operating margin has also gradually edged above 40%. As mentioned in earlier sections, continued capitalization on accelerating demand for higher-margin Intelligent Cloud offerings like those offered by Azure will continue to pave way for gradual margin expansion, albeit at a moderating pace over the longer term as the business matures. Meanwhile, Office margins are likely approaching a "steady-state" given its current size and maturity.
Overall, we remain confident that Microsoft's investment positives will continue to overshadow the near-term FX risks, which it is not alone in. Compared to SaaS peers with a similar international strategy, Microsoft is relatively better off, given its market leadership and the general stickiness of its cloud-based solution offerings in the commercial sector, especially productivity tools like Office 365. The company's diverse growth portfolio across key software categories, paired with a robust digital spending cycle across both the private and public sectors also serves as an effective insulation from the near-term macroeconomic uncertainties. The critical role of Microsoft's offerings in both the corporate and consumer digital fabric will continue to drive long-term growth, providing for robust valuation prospects ahead despite the near-term FX bump.
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Microsoft: Don't Stress Over The Slashed Guidance (NASDAQ:MSFT) - Seeking Alpha
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