Microsoft earnings: The quiet drive toward a $1 trillion market cap

Microsoft Chief Executive Satya Nadella has focused on the cloud and helped Microsoft’s sales grow at a pace unseen for nearly two decades.

While Apple and Amazon get the publicity, Microsoft just keeps clocking cloud gains on path to potential milestone

Apple Inc. received plenty of attention for being the first public U.S. company to achieve a $1 trillion market cap last quarter, and Inc. had its own momentary flirtation a month later.

Could Microsoft Corp. MSFT, -1.40% be the next to make a run at 13 digits?

Apple AAPL, +0.94% has maintained its $1 trillion valuation despite recent struggles in tech stocks, but Amazon — which has never closed a trading session atop the threshold — is now within Microsoft’s MSFT, -1.40% reach. As of the end of Monday trading, Amazon was worth $872.7 billion and Microsoft $841.7 billion, a difference of less than 4%.

When Microsoft announces first-fiscal-quarter earnings Wednesday after the bell, a day ahead of Amazon’s report, it will have another chance to show why it has regained its prominent place on Wall Street. In short: Chief Executive Satya Nadella has centered the company around the cloud, and the booming Azure cloud-computing business and adoption of Microsoft’s legacy software as a subscription service have led to sales and stock gains.

In the fiscal year that Microsoft wrapped with a report in July, revenue grew 23.3% from the year before to top $100 billion for the first time in its history. That is the highest annual growth rate Microsoft has managed since 1999, when Bill Gates was leading the most prominent tech company in the world at the height of the dot-com boom.

Investors have pushed Microsoft’s price higher even faster, as its share price has grown 39.1% in the past calendar year. Analysts still see a lot of room for growth, with an average price target more than 14% higher than the going rate. If Microsoft were to hit that target, its market cap would top $960 billion, within striking distance of the trillion-dollar mark.

Microsoft is “on pace” to become the next member of the trillion-dollar-market-cap club, Wedbush analysts wrote last week while initiating Microsoft with an outperform rating and 12-month price target of $140, which would secure the $1 trillion market cap.

“Strong positioning for ramping public cloud adoption, large distribution channels and installed customer base, and improving margins support a path to $50 billion in EBIT [earnings before interest and taxes] and a $1 trillion market cap,” Morgan Stanley analysts say in their investment thesis on Microsoft, which has led to an overweight rating and $130 price target — which would mean a $998 billion market cap at current share levels.

Microsoft still has a ways to go for $50 billion in EBIT, after collecting less than $35 billion last year, but GAAP earnings are set up for large annual percentage gains due to a $13.8 billion charge last year related to the new tax law. Sales growth is destined to slow: Analysts on average expect Microsoft to post sales growth for the first quarter of about 13.6%, according to FactSet, and revenue is expected to increase about 11.3% for the full fiscal year.

In earnings previews, analysts largely focused on margins and free cash flow for Wednesday’s report, as they look for Microsoft to turn its cloud growth into even more profit. If the company can manage that while hitting revenue expectations, Amazon’s spot in the market-cap standings and the $1 trillion milestone could be in Microsoft’s sights.

What to expect

Earnings: On average, 29 analysts tracked by FactSet expect Microsoft to report adjusted earnings of 96 cents a share, after a profit of 84 cents a share a year ago. Contributors to Estimize, a software platform that crowdsources estimates from hedge-fund executives, brokerages, buy-side analysts and others, are more bullish, calling for adjusted earnings of $1.01 a share on average.

Revenue: Analysts on average expect Microsoft to report first-quarter sales of $27.88 billion, according to a FactSet survey that found 27 analyst estimates, up from . Estimize, which received 272 estimates, reports a consensus of $28.1 billion.

Microsoft revenue is broken into three segments: “Productivity and Business Processes,” which is dominated by Office and other software offerings, and includes LinkedIn; “Intelligent Cloud,” which includes Azure as well as server sales and other enterprise services; and “More Personal Computing,” which is the legacy Windows and personal-computer business, as well as the company’s gaming and search businesses. Productivity and business processes is expected to bring in $9.39 billion, cloud is expected to record $8.28 billion in sales, and the PC business is projected by analysts to record $10.18 billion, according to FactSet.

Stock movement: Microsoft’s share price has increased in the session after its earnings report in three of the past five quarters, and seven of the past nine, though moves have not been huge. Shares increased 1.8% after last quarter’s report and 1.7% the quarter before, after falling 0.8% in February.

The stock has gained 28.2% for the year through Monday, as the S&P 500 index SPX, -0.55% has increased 3.1% and the Dow Jones Industrial Average DJIA, -0.50% , which counts Microsoft as a component, has risen 2.4%.

What analysts are saying

In aggregate, analysts are very positive on Microsoft, with 32 of the 36 analysts tracked by FactSet maintaining a buy rating or its equivalent on the stock, and only one calling on investors to sell the shares.

Stifel analysts warned that analysts may be modeling free cash flow that’s $1 billion too high due to tax payments, but they see potential upside in the results. “Microsoft continues to benefit from its strong positioning across major secular compute themes,” they wrote this week, reiterating a buy rating and a $118 share-price target.

Morgan Stanley analysts focused their pre-earnings note on Microsoft’s gaming business, writing that they don’t see a need for an acquisition of a large videogame publisher to bolster the Xbox division. They ran several models that showed smaller studio acquisitions and continued cooperation with other publishers would be the best course and would provide enough of the needed original content.

“With Microsoft checking the box on Cloud (Azure) and Community (XboxLive), we see an increasing focus on Content from Microsoft — the third ‘c’ required to win in Cloud Gaming (streaming),” they wrote.

Evercore analysts, with an outperform rating and $128 target, are interested to hear what Nadella and other execs say on the call about spending on gaming, as well as capital expenditures and research and development. They warned investors that Azure’s growth rate could be slowed by Microsoft’s device-management business, which is leveling off after rapid gains.

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