Microsoft (MICROSOFT) (MSFT.O): FY2023Q3 quarterly report comments, cloud computing demand stabilizes, focus on AI commercialization progress

In the face of macro headwinds, Microsoft relied on the recovery of Azure demand and the gradual introduction of AI products, and its performance this quarter still exceeded market expectations. At the same time, the company's follow-up guidance on Azure and AI also dispelled market concerns about the company's short-term fundamentals. Although the macro economy's uncertainty impacts the company's business, for Microsoft, a favorable product mix, stable cash flow, and shareholder returns are all excellent support for the company's stock price.

Looking forward to the second half of the year, with the receding of macro headwinds, the shift of the Federal Reserve's policy, the gradual introduction of AI products, and the optimization of cost structure, we expect the company's fundamentals to reverse in the second half of the year, and the investment value will still be relatively significant. We remain optimistic about the company's subsequent stock price performance and recommend focusing on the opportunity of the Fed's policy shift and the reversal of the company's fundamentals after the economy stabilizes.

The company achieved revenue of $52.9 billion in the quarter (+7% YoY, +10%cc). In this quarter, the company's overall gross profit margin was 69%, an increase of 1pct from the same period last year, and its operating profit reached US$22.4 billion (+10% year-on-year, +15%cc), corresponding to an operating profit margin of 42%, an increase of 1pct from the same period last year. Profit was $18.3 billion (+9% YoY, +14%cc). By sector, Productivity and Process Realization revenue were $17.5 billion (+11%, +15% net of exchange rates), Intelligent Cloud business revenue was $22.1 billion (+16%, +19%cc), and Personal Computing revenue was $13.3 billion (- 9%, -7%cc).

The company expects that the next quarter's performance will still be affected by foreign exchange, which will bring about a 2% headwind to the company's growth rate. Regarding business segments, productivity and process business revenue was US$17.9-18.2 billion, smart cloud revenue was US$23.6-23.9 billion, and personal computing revenue was US$13.35-13.75 billion. On the cost side, the company expects COGS to be US$16.8-17 billion and operating costs to be US$15.1-15.2 billion. The outlook on cloud and AI dispelled the market's previous concerns about the company's fundamentals, and the market gave the company's stock price a positive performance.

In this quarter, the company's intelligent cloud achieved revenue of US$22.1 billion (+19%cc, higher than the previous guidance midline), of which Azure +31%cc year-on-year, higher than market expectations, and Server business +2%cc year-on-year, in line with expectations—corporate services revenue +9%cc, mainly due to the impact of the decline in the consulting business. From the perspective of Azure, the company expects the year-on-year growth rate of Azure to be 26% to 27%. The recovery of Azure consumption drives the growth. Toughness.

We believe that the long-term resilience of Azure is still outstanding. Azure maintains good linkage with Microsoft 365, Teams, etc., and after destocking, with the upward trend in usage, Azure's mid-to-long-term growth is still worthy of attention. Microsoft Cloud has US$196 billion in business orders, and the follow-up reserves are still sufficient. In addition, the company proposed in the Azure guidance that AI will contribute about 1% of the revenue growth rate, showing the positive progress of the AI business.

Affected by macro headwinds such as high inflation and rising channel inventory levels, Windows OEM business revenue decreased by 28% year-on-year. The income of the Office365 commercial version increased by 14% (+18%cc) year-on-year, the number of subscriptions increased by 11% year-on-year, and the number of Microsoft365 subscriptions increased to 65.4 million, showing the resilience of Office-related businesses. Windows commercial products and cloud revenue increased by 1% (+4%cc) year-on-year, mainly due to the slowdown in demand from SMEs and PC headwinds; Surface revenue decreased by 30% (-26%cc) year-on-year; ex-TAC search advertising increased by 10% year-on-year % (+13%cc), showing headwinds in the overall advertising market; game revenue in this quarter fell by 4% year-on-year, of which hardware revenue fell by 30% year-on-year, mainly due to the decline in per capita usage time and monetization rate, content revenue +3% year-on-year %, driven by Xbox Game Pass.

The current complex and changeable macro-environment have suppressed enterprise IT spending, putting the company's cloud, PC, and other businesses under short-term pressure. However, Microsoft's performance this time shows the company's resilience against macro headwinds and the bottoming out of IT spending by European and American companies.

We believe that the abovementioned headwind will likely improve after CY3Q23, and market expectations are reasonable to be close to the bottom. In addition, the company has further deployed OpenAI and other advanced AI products in the intelligent cloud, strengthening the company's full-stack capabilities. According to the disclosure of the company's financial report, the company now has more than 2,500 Azure OpenAI service customers, an increase of 10 times from the previous month. The daily installation volume of Bing mobile applications has increased four times, and the market share has also increased. The utilization rate of Teams has reached a record high. Monthly active users exceeded 300 million during the quarter.

On the profit side, as the company's cost reduction and efficiency increase effects appear and the continuous advancement of mergers and acquisitions integration, the company's profitability is expected to gradually improve in the long run. For the whole year, the company guides that FY23 will still achieve double-digit growth after deducting the impact of exchange rates. For FY24, the company will continue to invest in AI ​​and ensure its leading position.

Risk factors: supply chain problems caused by the global economic recession and risks of macroeconomic weakening; downside risks of demand brought about by high inflation; risks of continued intensification of competition in the cloud computing market; risks of integration after mergers and acquisitions of new businesses; risks of loss of core technical personnel; depreciation expenses The risk of revenue and profit decline due to accounting confirmation and epidemic-related restriction policy changes; the US government's anti-monopoly and other policy and regulatory risks.

Investment suggestion: The first quarterly report shows the company's strong resilience against macro headwinds, and the follow-up outlook also dispels market concerns about the company's short-term performance. We believe that driven by the subsequent policy shift of the Federal Reserve and the continuous improvement of the company's fundamentals, the company's medium and long-term investment value is still outstanding. Considering the company's performance guidance, we adjust the company's profit forecast. It is estimated that the company's FY2023-FY2025 revenue will be 2115/2447/277.8 billion US dollars (original forecast 2081/2344/261.2 billion US dollars), net profit will be 722/855/98.3 billion US dollars (original forecast 701/798/89 billion US dollars), we continue Optimistic about the company's follow-up performance.