Microsoft FY24 Q4 Earnings Review: Azure Growth Slows, Sparking Concerns

So, what is Microsoft's current investment value, and should you consider buying the dip? Let's dive deeper into Microsoft's performance.

Microsoft's performance primarily comes from three major business segments:

- Intelligent Cloud: Includes Microsoft Azure, Windows Server, and related data center services.

- Productivity & Business Processes: Encompasses Office software and productivity tools.

- More Personal Computing: Includes the Windows operating system, Bing search, personal hardware business, and Xbox gaming.

Among these, the Intelligent Cloud business is Microsoft's core, with the largest revenue share and significant growth potential. Within the Intelligent Cloud business, Azure is the main revenue contributor, making its performance a key focus of the earnings report.

Source: Company Announcements

In FY24 Q4, Microsoft's revenue grew 15.2% year-over-year to $64.727 billion, with Intelligent Cloud revenue rising 18.85% year-over-year to $28.515 billion. However, Microsoft's Azure revenue growth slowed from 31% last quarter to 29%, missing market expectations.

Source: Company Announcements

Compared to Google's better-than-expected cloud performance, Microsoft's slowing cloud growth further raised market concerns.

The slowing growth of Microsoft's cloud business highlights issues with AI investment returns, as the return period is too long. AI services contributed about 8% to Azure and other cloud service revenues this quarter, slightly higher than 7% in Q3 and 6% in Q2, but the overall contribution rate is improving slowly. Meanwhile, Microsoft's AI investment is enormous, with capital expenditures up 55.13% year-over-year this quarter and 58.24% for the fiscal year. Given the significant capital expenditure growth, the slowing impact of AI on revenue growth is concerning, and the rising AI investment costs also negatively impact profits. The operating profit margin for the Intelligent Cloud business declined to 45%, the lowest level for the fiscal year.

Revenue from the Productivity and Business Processes segment grew 11.8% year-over-year to $20.317 billion, with growth slowing slightly but not significantly. As a traditional business for Microsoft, it remains relatively stable, mainly benefiting from the growth in Office 365 commercial revenue.

Since Office 365 uses a subscription model, the number of subscriptions is a key performance indicator. From the growth in Office 365 commercial seats, it is clear that the business segment still lacks new growth drivers. Office 365 commercial seats grew 7% year-over-year this quarter, the lowest for the fiscal year; Microsoft 365 consumer subscriptions grew 10% year-over-year to 82.5 million, still relatively small in scale.

Copilot has the potential to become a new growth engine, but its large-scale commercialization has not yet reached a turning point. Considering that consumers are still in the acceptance phase of Office 365's Copilot services, it will take some time before Office 365 subscribers widely adopt Copilot services. Additionally, the computational and economic costs of running this business are high, so the real breakout period for this business is expected to take some time to materialize.

Revenue from the More Personal Computing segment grew 14.31% year-over-year, with about 12% of the growth attributed to the acquisition of Activision Blizzard. Following the acquisition, the gaming business has become the fastest-growing segment within More Personal Computing, second only to Windows in revenue share. The impact of the Activision Blizzard acquisition is expected to continue into the next quarter, with future growth returning to single-digit levels.

Besides gaming, the Windows and search businesses maintained single-digit growth. Considering that these businesses are heavily influenced by macroeconomic factors and have relatively stable market shares, significant changes in growth rates are not expected.

Overall, the double-digit growth in More Personal Computing is expected to end next quarter as the impact of the Activision Blizzard acquisition fades, returning to single-digit growth.

On the profit side, the company’s adjusted gross margin and operating margin for the quarter were 69.59% and 43.13%, respectively, both down from the previous quarter. Notably, adjusted diluted EPS grew by 9.67% year-over-year this quarter, a sharp decline from the 20%+ growth seen in the previous three quarters, primarily due to increased expenses from higher capital expenditures.

Source: Company Announcements

This quarter's free cash flow was $18.315 billion, down 13.36% year-over-year, mainly due to the significant increase in capital expenditures. Considering the company's capital expenditures are still on the rise, the slowdown in free cash flow growth is expected to negatively impact shareholder returns.

Source: Company Announcements

In terms of earnings guidance, the company expects growth to slow across all business segments. For FY24 Q4, the Intelligent Cloud segment is expected to grow 18%-19% year-over-year to $28.6-28.9 billion, with Azure growing 28%-29%, further slowing down; the Productivity and Business Processes segment is expected to grow 9%-11% year-over-year to $20.3-20.6 billion; and the More Personal Computing segment is expected to grow 9%-12% year-over-year to $14.9-15.3 billion.

Given the ongoing expansion of capital expenditures and the short-term difficulty in significantly improving AI investment returns, the expected increase in costs and expenses will likely impact the company’s EPS. Next quarter’s EPS growth is expected to remain in the single digits, and FY25 EPS growth is expected to slow significantly from FY24’s 20.29%, falling to low double-digit growth.

Moreover, Microsoft’s shareholder returns are not particularly impressive. In FY24, Microsoft spent a total of $34.3 billion on buybacks and dividends. Given the current market value, the annualized shareholder return is only 1.1%, much lower than other tech giants like Apple and below the current risk-free rate in the U.S., offering a generally low margin of safety. Microsoft’s current valuation is a PE (TTM) of 35.84x, which is on the high side. Considering the significant slowdown in EPS growth, the stock may face downside risk.

For investors holding the stock, it may be wise to consider taking profits or adopting a covered call strategy in the short term. For those not holding the stock, it may be prudent to wait for a price pullback before buying in, or use a sell put strategy to lower the entry cost.

Additionally, investors can use leveraged ETFs for exposure.