Microsoft investors still assured by Azure

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By :  ,  Financial Analyst
The outlook remains cloudy for Microsoft, in a good way, ahead of quarterly earnings

Microsoft Corp reports Q1 2020 earnings on Wednesday, after the U.S. market close, here’s what we’re keeping an eye on. 

(All consensus forecasts sourced from Bloomberg).

The strength of its Azure cloud keeps MSFT’s outlook reaching for the skies. Furthermore, a deeply embedded installed base of productivity users means the group is better equipped to weather changing economic phases better than most peers. That said, cloud growth—which dominates investor attention— is called to slow over the next 12 months as the market matures. An average 74% rise at the Azure flagship over 4 quarters could soon moderate to the high 50%-60% levels, though that would still be twice the pace of the cloud services market. In turn, although the stock outpaces the Nasdaq 100 index this year with 30%-plus gains, moderating quarterly sales advances may bring headwinds for the shares into year end. Consensus adjusted EPS forecast: $1.24, +9.5%. Consensus revenue forecast: $32.22bn, +10.8%

Key points to watch
With group cloud assets housed largely in Microsoft’s Intelligent Cloud unit (incorporating Azure), it will garner outsize attention, as it has for dozens of quarters, given stellar growth. Intelligent Cloud revenues are forecast to jump 22% on the year. Within the cloud unit, the flagship business, Azure, could still post further boom-like growth of 75%, if consensus proves accurate. 

Detailed group forecasts
  • Q1 adjusted EPS: $1.24 (range: $1.20-$1.32)
  • Q1 revenue: $32.22bn (range: $31.85bn-$32.83bn
  • Q1 gross margin: 66.9%
  • Q2 adj. EPS guidance estimate: $1.27
  • Q2 revenue guidance estimate: $35.93bn

Possible market reaction
  • Having shot higher than most Nasdaq technology leaders in recent quarters, Microsoft shares have been fairly static since July earnings. (The stocks is up 34% in the year to date. The Nasdaq 100 index has risen 24%)
  • Global growth, trade and other geopolitical concerns have taken a toll. At the same time, Microsoft shares are tracking to the higher end of cloud and virtualisation peers on a host of multiples. MSFT’s 19.8 times Enterprise value-to-core earnings ratio is 9% above average. Some of the quarter’s static share price progress could therefore be down to valuation worries compounded by uncertainties about the pace of any global slowdown. Should broader growth worries deepen, richly valued shares, like MSFT, could come under pressure. MSFT’s outlook commentary will therefore be more pivotal than usual
  • Although cloud revenue progress is expected to moderate in quarters ahead, forecast expansion in the first quarter of fiscal 2020 show investors are still setting the bar high. As such, any disappointment from what is, essentially, Microsoft’s most important business segment right now would be a big deal. The shares would probably react negatively, as they have following past quarterly reports that suggested cloud growth could soon become more hesitant

Options trades point to a move of at least 4% post earnings. The average one-day move over the past 8 quarters has been 2.7%, with 6 gains and two declines. Calls outnumber puts by 1.78-to-1 right now, giving a strongly bullish bias to expectations. However, traders should note that implied volatility in MSFT is running at 68%, sharply higher than the 21% 90-day average. This means that violent whipsaws are more likely, almost regardless of how the group’s earnings are received.

Read a technical analysis outlook for Microsoft by my colleague, Kelvin Wong, here

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