Microsoft earnings: It’s the forecast that matters, so be patient

While that guidance reduction was pinned on a stronger dollar, there are many more scary indicators for Microsoft. With third-party analysts reporting that personal-computer shipments hit their biggest decline in years during the quarter and the business clients on which Microsoft relies signaling a slowdown in spending, there will be more sweaty palms than usual waiting for Microsoft’s results.

“Heading into the quarter, investors are understandably concerned with multiple cross currents potentially impacting Microsoft’s results and outlook into FY23: PC shipment declines pressuring Windows OEM results, FX headwinds, a weakening consumer and overall macro weaknesses all serve as potential risks,” Morgan Stanley analysts wrote in a preview of the report last week.

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The answers to investors’ questions will likely not arrive with the news release announcing the results, however. The most important information Microsoft will provide is its forecast, which executives hold for the ensuing conference call — scheduled for 5:30 p.m. Eastern — and provide in pieces after Chief Executive Satya Nadella gives his quarterly stump speech on “digital transformation” and Chief Financial Officer Amy Hood breaks down the stated quarterly results.

In each of the past two quarters, Microsoft’s stock has slipped into the red after the company reported strong numbers, then flipped to green after the forecast was provided roughly two hours later. Expect much of the same Tuesday afternoon, as investors await news about what Microsoft executives foresee in the fiscal year ahead.

What to expect

Earnings: Analysts on average expect earnings of $2.29 a share, according to FactSet, down from $2.33 a share expected before Microsoft revised its outlook. That would still be an increase from $2.17 a share reported in the fiscal fourth quarter a year ago.

Estimize, which crowdsources projections from hedge funds, academics, and others, reports an average estimate of $2.34 a share.

Revenue: Analysts on average expect sales of $52.39 billion, according to FactSet, down slightly from $52.9 billion before the revision. Estimize contributors expect $52.85 billion on average. Microsoft reported revenue of $46.15 billion in the fourth quarter a year ago.

Stock: Microsoft shares have gained after the past three earnings reports, following a run of declines in four of five post-earnings trading sessions. Shares do not tend to move violently in either direction, however: the stock hasn’t moved more than 5% the day after earnings in the past 14 quarters.

The stock has declined 23% so far in 2022, as of the end of Monday’s trading session, while the S&P 500 index
SPX,
+0.13%
has dropped 16.1% and the Dow Jones Industrial Average
DJIA,
+0.28%
— which counts Microsoft as a component — has fallen 12.2%.

What analysts are saying

Morgan Stanley analysts, who have an overweight rating with a $354 price target and call the stock “one of our favorites in software,” laid out three things that Microsoft needs to do to overcome the current fears.

First, Microsoft needs to ensure investors that Azure, its cloud-computing product, is holding up through the economic upheaval. They are looking for 47% growth in constant currency in the fourth quarter, which CFO Hood guided for in the last report, and guidance that calls for that figure to remain in at least the low-40s in the first quarter. (Microsoft only provides a revenue growth figure in percentages for its cloud product, even though rivals Amazon.com Inc.
AMZN,
-1.05%
and Alphabet Inc.
GOOGL,
-0.36%
GOOG,
-0.14%
provide a full breakout of their similar products.)

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Second, they believe Microsoft needs to “de-risk the outlook for FX, PCs and a weakening consumer,” without offering many ideas for how executives would accomplish that feat. Third, they believe Microsoft executives need to maintain their guidance for double-digit growth in operating income, though they will accept if executives add the caveat that it would only be in “constant currency,” which factors out the strengthening dollar.

“Adding a modifier of ‘constant currency’ to the FY23 commentary would still likely be seen as a constructive outcome for investors and reinforce Microsoft’s standing as the steadiest of ships within stormy software seas,” they wrote.

Wedbush analyst Dan Ives agrees with Morgan Stanley analysts that Azure growth is the first priority for Microsoft, amid doubts that the strong growth rates in recent years can continue in a possible recession.

“We believe given the macro storm clouds on the horizon, all focus will be Nadella’s comments and guidance around Azure growth heading into FY23, which we believe the line in the sand is north of 40% growth as a barometer for the Street heading into FY1Q,” he wrote in a preview, while maintaining an outperform rating and $340 price target.

Jeffries analyst Brent Thill believes that foreign-exchange rates “will have a more pronounced impact on F1Q guidance,” as the dollar has continued to strengthen since Microsoft revised its guidance in early June. He expects guidance to be conservative as a result, but maintains a buy rating and $320 price target even as he admits “valuation remains elevated at a 23.5x cons.”

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While there are concerns about Microsoft’s ability to continue posting strong Azure growth rates and weather macroeconomic issues along with a decline in PC sales, most analysts believe the company will be just fine even if those concerns prove valid in the months to come.

“Microsoft continues to screen as the highest-quality name in our coverage with reasonable price-to-quality that should prove a relative advantage in the current environment,” Deutsche Bank analyst Brad Zelnick wrote, while maintaining a buy rating. “Much of our field work suggests IT spending is beginning to weaken, and we believe that if the environment is tough for Microsoft, then it’s likely even tougher for most others.”

None of the 44 analysts covering Microsoft that FactSet tracks rate the stock a sell. Only two rate shares a hold while the other 42 all have a buy rating or equivalent on the stock. The average price target as of Monday afternoon was $339.84, suggesting implied upside of more than 31% from the current price.