Microsoft gets a price target hike after posting a great quarter driven by AI

Microsoft reported strong fiscal second-quarter results Tuesday, boosted by the strength of AI. It also announced two new positive developments: solid revenue guidance for the third quarter and talk of a slight margin expansion for the year. Revenue increased about 17% year over year, to $62.1 billion, beating the Street consensus estimate of $61.1 billion, according to data from LSEG. Adjusted earnings-per-share (EPS) increased 33% from last year, to $2.93, ahead of estimates for $2.76 a share, LSEG data showed. But a great quarter doesn’t always generate a positive move after earnings. Here’s what we think. Bottom line Microsoft shares were flat in post-market trading on Tuesday. Due to the recent rally to new all-time highs, which helped the company join the exclusive $3 trillion market cap club, the stock was simply priced to perfection. Shares are up more than 8% in January, outperforming the broader market yet again after its strong 2023. Expectations matter, and in the case of Microsoft, it looks like expectations got a bit too lofty. And that’s ok if the company is doing well, which is the case here. Cloud unit Azure was better than expected thanks to organizations running AI applications on its cloud. In addition, Copilot’s long-term monetization opportunity continues to look robust thanks to more than 400 million paid users of Office 365, and management’s focus on efficiency is keeping margins intact despite ongoing investments. Microsoft’s results solidify the stock’s run to the highs, and continued execution of its AI strategy should take shares still higher over time. We’re reiterating our 2 rating, because we think the stock is due for a breather given its long run. But this would be a priority mega cap tech name to add to on a pullback given the quality of quarters it consistently delivers. We are raising our price target to $450 from $400. Quarterly results It wasn’t a clean sweep of beats this quarter, but Microsoft got pretty close. The largest upside surprise on a dollar amount basis came from the Intelligent Cloud segment, which saw revenues increase by roughly 20% from last year, ahead of expectations of about 17.5% growth. All the focus here was on Azure, Microsoft’s cloud services business, and it delivered strong results with revenues up 30% year over year, topping estimates of about 27.6%, and 28% on a constant currency basis. Its growth rate picked up about 1 percentage point from the September quarter but was flat on a constant currency basis. AI services were a big part of Azure’s upside, contributing 6 points of growth in the quarter. That’s double from last quarter as Azure AI customers grew to 53,000 from more than 18,000 last quarter. What’s fascinating about Azure AI is that over one-third of its customers are completely new to Azure, according to Microsoft, highlighting the importance every organization has in understanding its AI strategy. CEO Satya Nadella believes Azure took share in the quarter because it offers the top performance for AI training and inference and offers the best selection of AI accelerators from Nvidia , AMD , and its in-house silicon. The boost from AI is likely helping Azure offset some of the “cost optimization” headwinds we heard the major cloud players discus for the better part of the past two years. That period is just about over, management explained on the conference call. Microsoft said it is currently seeing “larger and more strategic” deals with an increase in the number of $1 billion-plus commitments. Productivity and business processes revenues increased by 13%, well ahead of expectations mostly due to better-than-anticipated results from LinkedIn, which saw an 8% increase in sales. Office commercial products revenue increased by 13% while consumer products revenue increased by 4%. 365 Copilot is what everyone wants to hear about given the excitement around this everyday AI assistant. The company recently started charging $30 a month for as an add-on to 365 software bundles. Microsoft said it now has over 1.3 million paid Copilot subscribers, up 30% from the last quarter and it has only scratched the surface as a revenue contributor to Microsoft. Revenue in the More Personal Computing segment grew for the second quarter in a row, putting an end to the weakness brought on by the PC market. A large portion of the year-over-year growth was from the inclusion of $2.08 billion of revenue from Activision Blizzard, but it still would have showed slight growth without this contribution thanks to high single digit increases in Windows OEM revenue growth and Windows Commercial products and cloud services revenue growth. Operating income missed, but the Activision business had an operating loss of $437 million in the quarter and that explains the bulk of the difference. Despite the drag to operating income the ATVI deal had on Microsoft, its margins actually expanded nicely in the quarter to 43.59%, beating the Street at a little below 43% and up from sub 40% last year. Cash flow was strong too, even with the $9.7 billion it spent for property and equipment. The company repurchased $2.8 billion worth of stock in the quarter. Note: Constant currency growth rates help strip out fluctuations in foreign currency, namely a strong U.S. dollar, to provide a clearer financial picture. Guidance Management’s revenue outlook was slightly lighter than expected, but it was strong where it counts. It expects revenue in the fiscal third quarter to be about $60 billion to $61 billion, bracketing the consensus of about $60.68 billion, but it was higher than expected in the two segments that matter most. Microsoft guided Productivity and Business Processes revenues to $19.3 billion to $19.6 billion, ahead of the consensus of $19.45 billion. In Intelligent Cloud, revenue is expected to be $26 billion to $26.3 billion, which is above the consensus of just under $26 billion thanks to continued strength in Azure, where growth is expected to remain stable from its second-quarter levels, implying upside from the roughly 27% consensus figure. In addition, Microsoft continues to aptly balance investments in its long-term initiatives with focusing profitability. The company is doing this just as well as anyone. It expects third-quarter operating expenses to be $15.8 billion to $15.9 billion, which is well below estimates of about $16.8 billion. And due to the strength of its results through the first half of its fiscal year and its ongoing commitment to driving efficiencies, it now expects operating margins to be up 1 to 2 points year over year versus prior expectations of roughly flat. (Jim Cramer’s Charitable Trust is long MSFT. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . 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