Can Microsoft (MSFT, Financial) shares continue their strong performance from the first quarter of 2023? It may be tempting to think so due to flashy headlines on things like artificial intelligence (AI) and other technology developments. However, the bulk of the company's revenue stream is in danger, which is why I believe the strong momentum of Microsoft's stock could be put to the test in the remainder of the year.
Bullish news
Starting with the good news, Microsoft announced a cash dividend of $0.68 with an ex-dividend date of Feb. 15, 2023.
On Feb. 14, Morgan Stanley (MS, Financial) upgraded Microsoft stock, claiming “Near-term cyclical impacts create an attractive entry point into one of the best secular growth stories in tech." Morgan Stanley puts a price target of $307 on the stock, which implies about a 12% upside from its closing price of $272.17 on the day of the upgrade.
Of course, the thing that's all over the news is how Microsoft invested $10 billion in Open AI's ChatGPT, which is a large language model that is capable of a multitude of tasks including answering questions, compiling lists, generating paragraphs of text and writing code across multiple computing languages. One of the business goals for Microsoft in this regard is to strengthen its search engine Bing.
Microsoft plans to defend its Activision Blizzard (ATVI, Financial) deal at a European Union hearing on Feb. 21, after the company has received warnings about the possible anti-competitive effects of the deal. However, Microsoft remains confident the deal can go through.
Latest earnings
For the quarter that ended Dec. 31, 2022, Microsoft announced mixed results. The company brought in adjusted earnings per share of $2.32, beating estimates by $0.01, and GAAP EPS of $2.20, which missed expectations by $0.07. Revenue was $52.75 billion, a miss of $404.99 million. Compared to the corresponding period of the last fiscal year, revenue increased by 2%. Operating income was $20.4 billion on a GAAP basis and $21.6 billion on a non-GAAP basis, which decreased by 8% and 3%, respectively, from the year-ago period. Net income was $16.4 billion, down 12%.
The PC business weakened in December, but there was strong momentum in the Cloud revenue. “We are focused on operational excellence as we continue to invest to drive growth. Microsoft Cloud revenue was $27.1 billion, up 22% (up 29% in constant currency) year-over-year as our commercial offerings continue to drive value for our customers,” said Amy Hood, executive vice president and chief financial officer of Microsoft.
Microsoft called for $50.5 billion to $51.5 billion in revenue for the next quarter, which is below analysts’ expectations of over $52 billion. The focus will be on Azure's growth trend.
PC sales declines impending
The elephant in the room that no one seems to be paying attention to is the expected further decline in PC sales. According to Gartner, "Worldwide shipments of total devices (PCs, tablets and mobile phones) are projected to decline 4.4% in 2023, to total 1.7 billion units." In 2022, the devices shipment market declined 11.9%.
“The depressed economic market will continue to dampen demand for devices throughout 2023. In fact, end-user spending on devices is projected to decline 5.1% in 2023,” said Ranjit Atwal, Senior Director Analyst at Gartner. “Just as business confidence was beginning to recover after the worst of the pandemic, it has now fallen significantly in most regions. We do not expect relief from inflation and the bottom of the recession to occur until the fourth quarter of 2023.”
Fundamentals
Microsoft has a very strong balance sheet with a quick ratio of 1.66, a current ratio of 1.93, an interest coverage ratio of 42.52 and a debt-to-equity ratio of 0.33. The net margin of 33.05% and return on equity of 39.31% are very strong.
The five-year trend in sales is rising, gross income is steadily rising and has lately stabilized at a growth rate of about 17% to 19.52%, and net income is rising, although in 2022 there has been a slowdown in growth compared to 2021. Ebitda growth is also rather stable at a rate of 20% to 24% over the past four consecutive years. Microsoft has been generating increasing net operating cash flows over the past four consecutive years and free cash flow growth has been very consistent, although there was a decline to 16.09% growth in 2022 compared to growth of 24.06% in 2021.
Valuation
Microsoft stock has a price-earnings ratio of 30.24, which is pricey compared to the sector median of 26. The price-sales ratio for Microsoft is 9.69, compared to the sector median value of 2.96, a difference of 228.00%. The GF Value chart rates the stock as modestly undervalued:
Technical analysis
Microsoft stock is up 21.59% so far in 2023. The daily chart is bullish as the stock is now trading above the 50-day simple moving average, 200-day simple moving average and 20-day simple moving average. The MACD indicator is positive and rising, and there is a moderate uptrend as the ADX/DMI indicator stands at 33.10, suggesting a strong trend is underway.
Final word
Overall, I don't think shares of Microsoft are cheap, and the global decline in PC shipments is the key problem. AI investments will likely take a bit of time to pay off in terms of profitability as well.
