Solid Quarter for Microsoft, But Shares Fairly Valued
The wide-moat firm's cloud initiatives were the highlight for the quarter, but we’d wait for a larger margin of safety before investing, says Morningstar’s Norman Young.
Commentary
Microsoft (MSFT) reported first-quarter results that were within our range of expectations, as the commercial business continued its solid performance. The firm's cloud initiatives were the highlight for the quarter, with strong growth rates across Office 365 and Azure. We are sticking with our $46 fair value estimate and wide moat rating for now.
Revenue grew 25% from last year to $23.2 billion as the phone business added $2.6 billion. Excluding phone, revenue growth would still have been an impressive 11% year over year, driven by strength in Xbox and the cloud businesses. Windows OEM revenue declined 2% as the PC replacement cycle has largely run its course. Consumers and enterprises are transitioning to Office 365, which has weighed on Office revenue in both businesses, but the company saw gains in subscription revenue and adoption of premium stock-keeping units.
Microsoft's traditional revenue and profit driver, the commercial business, once again showed strength despite competitors' recent lackluster results. The company's traditional data center products, SQL server, System Center, and Windows Server, grew double digits, with total server products growing 11% year over year.
Not surprisingly, profitability was weaker this quarter, as the inclusion of the phone business and its associated restructuring weighed on margins. Gross margin of 55.4% was below last year's 67.9% and operating margin of 31.5% was below last year's 39.4%, although just ahead of our 31.3% estimate. GAAP earnings per share of $0.54 was just under our $0.56 estimate and below last year's $0.62.
This was largely a positive quarter for the company, even with the headwinds of integrating and restructuring the phone business. Traditional areas of strength remained solid, but the bright spot in the quarter was the growth and improving scale of the cloud businesses. We view Microsoft as a key technology holding, but would prefer a larger margin of safety before investing.
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