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Stock Analyst Update

Microsoft Delivers Flawless Third Quarter

We’re raising our fair value estimate for the wide-moat firm and view shares as attractive.

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Wide moat-rated  Microsoft (MSFT) reported third-quarter results that came in far ahead of management’s prior guidance and our expectations, as the company saw strong growth across each of its key product franchises. On the cloud front, Azure delivered its 15th consecutive quarter of triple-digit premium services growth, while Office 365 commercial revenue grew 42% in the quarter. 

Management also continues to execute on its LinkedIn integration, as the business is seeing accelerating revenue growth and improving profitability. CFO Amy Hood provided strong fourth-quarter guidance and offered an initial outlook for fiscal 2019 that signaled continued strength across Microsoft’s most important products, including double-digit growth in Productivity and Business Processes and consistent gross margin expansion in the firm’s cloud businesses.

After accounting for this outlook and baking in greater Office 365 and LinkedIn revenue growth long term, we are lifting our fair value estimate to $117 per share from $106 previously, and we continue to view the shares as attractive.

Third-quarter revenue rose 16% versus the prior-year period to $26.8 billion as the firm lapped a full quarterly contribution from LinkedIn for the first time. Not only is Microsoft generating elevated, sustained top-line growth, but we are beginning to see scale efficiencies enter its cloud businesses, yielding uplift in profitability. Commercial cloud gross margins (which includes Azure, Office 365, Dynamics 365, and Enterprise Mobility Suite) expanded 600 basis points year-over-year and 200 basis points sequentially to 57%, while consolidated operating margins expanded nearly 200 basis points to 30.9%. Management anticipates the firm will continue to see Commercial Cloud gross margin gains continue in fiscal 2019, and we forecast gross margins expanding roughly 50 basis points to 65%.

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Rodney Nelson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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