Microsoft shares jump 4% after the big AI winner delivers in all the right places

Microsoft delivered picture-perfect earnings after the bell Thursday, calming the market’s brief fears about runaway spending on AI infrastructure without the cloud revenues to show for it. Revenue increased about 17% year over year, to $61.86 billion, beating the Street consensus estimate of $60.8 billion, according to data from LSEG. Earnings per share (EPS) increased 20% from last year to $2.94, ahead of estimates for $2.82 a share, LSEG data showed. Microsoft Why we own it : Microsoft is a core backbone of global productivity thanks to its Office 365 suite and hybrid cloud platform Azure. The company is also proving itself to be a key provider of artificial intelligence tools due, in part, to its large investment in OpenAI, the startup behind ChatGPT. We also like what it’s doing in the video gaming industry as looks to grow recurring revenue streams. Competitors : Amazon , Alphabet and Salesforce Weight in portfolio : 2.75% Most recent buy : Aug. 21, 2023 Initiated : Dec. 4, 2017 MSFT YTD mountain Microsoft YTD Bottom line You couldn’t ask for much more from Microsoft. The company delivered beats across every single line we focus on. Sure, total revenue for the next quarter was a little mixed. And that always matters. However, momentum from AI services will keep Azure growth stabilized at these high levels, outperforming the market’s expectations. As for the other segments, we wouldn’t sweat it because management has a history of outperforming its guidance. We also remain impressed by the high level of execution. It’s one of the clearest AI beneficiaries in all of tech. We don’t see any issues in management’s ability to balance investments to support its AI leadership while remaining disciplined on costs and margins. The stronger-than-expected quarter and upbeat Azure revenue guide are sending shares up more than 4% in after-hours trading, helping the stock recover all of Wednesday’s losses and then some. The move to about $418 after hours puts MSFT about $11 per share below its all-time high close in March, and it’s reasonable to think it could take out those highs over time. We are raising our price target to $500 from $450 and view pullbacks on broader market volatility from inflation fears as opportunities to add to our position. Quarterly results The quarter was clean with beats across the board. The Intelligent Cloud division posted sales above the high end of guidance with revenue growth of about 21%. As with every quarter, the key line was revenue growth from Azure, Microsoft’s cloud services business. Azure and other cloud services revenues increased 31% year over year on a reported and constant currency basis, accelerating from the prior quarter’s reported rate of 30%, and 28% in constant currency, exceeding investor expectations and guidance of about 28% and change. The 31% growth rate was faster than the 28% Google Cloud grew this quarter, and that came off a smaller base. We’ll see how Amazon fares next week. Once again, Microsoft touted share gains as more and more customers used Azure’s platforms and tools to build their own AI solutions. The number of $100 million-plus Azure deals increased 80% year over year and the number of $10 million-plus deals more than doubled. AI services continue to be a large source of revenue growth, contributing seven percentage points of growth. That’s a slight acceleration from the 6 points last quarter. Some could argue that the growth should be faster given the proliferation of AI, but Microsoft explained on the call that its demand exceeds supply. These revenues come from Microsoft’s tie-in with ChatGPT and OpenAI. Adoption of Azure OpenAI continues to grow, with more than 65% of the Fortune 500 currently using the service. Productivity and Business Processes revenues grew by nearly 12%, edging expectations, driven by Office 365. The Office Commercial Products and Cloud Services revenue rose 12%, while the Office Consumer Products and Cloud Services revenue grew 4%. Both rates were relatively consistent with the prior quarter. The gains came as Office 465 commercial continued to add more seats, up 8% in the quarter, while the total number of Microsoft 365 consumer subscribers was 80.8 million, up 2.4 million from the prior quarter. This was the first quarter of sales of the 365 Copilot add-on for commercial customers. CEO Satya Nadella said nearly 60% of the Fortune 500 is using the AI tool, and there’s been an acceleration in adoption across industries and geographies. Some of the Copilot customers Nadella highlighted on the call were Amgen , Novo Nordisk , and Nvidia . Revenue in the More Personal Computing segment grew 17% year over year, or 2% when excluding the net impact from the Activision acquisition. Windows OEM revenue increased by 11%, its third quarter in a row of growth as PC market volumes recovered to pre-pandemic levels and were better than management’s expectations. The ongoing recovery in the PC market should support our Best Buy investment thesis, which is largely based on the electronics cycle. AI-powered PCs coming out later this year should accelerate the recovery. Windows Commercial Products and Cloud Services revenue increased 12%, driven by demand for Windows 365. Search and News Advertising excluding traffic acquisition costs were up 12% on higher search volumes, while gaming revenue increased significantly because of the Activision deal. On a company level, we’re pleased to see both gross margins and operating margins expand despite the higher levels of investment needed to support Microsoft’s AI buildout for both training and inference. Training is a key focus for Nadella. He explained on the call that he wants Microsoft “to be a leader in this big generational shift and paradigm shift in technology” on the training side. That’s great for Microsoft and even better for Nvidia, given that its platform is by far the best for training. Guidance Management’s revenue outlook for the final quarter of its fiscal year was mixed. The team expects revenue in the range of $63.5 billion to $64.5 billion, with a midpoint of $64 billion falling short of estimates of $64.6 billion. By segment, the only higher-than-expected outlook was Intelligent Cloud, which management guided revenues to between $28.4 billion and $28.7 billion versus estimates of $28.48 billion. The company guided Azure’s constant currency revenue growth to 30% to 31%, which is higher than estimates of 29%. So the beat was where it counts. However, both Productivity and Business Processes and More Personal Computing revenue fell slightly short of consensus. On a company basis, operating margins for the full fiscal year 2024 are expected to be up more than two points from last year, which is higher than management’s prior guide of up one to two points. Management is laser-focused on driving efficiencies and maintaining disciplined cost management, knowing that it will need to continue to invest heavily in cloud and AI next year. It should not be a surprise to hear management say it expects fiscal year 2025 capital expenditures to be higher than fiscal year 2024. For fiscal year 2025, Microsoft said it expects double-digit revenue growth and operating income growth, with operating margins down by about one percentage point year over year. (Jim Cramer’s Charitable Trust is long MSFT, AMZN, GOOGL, CRM. 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. 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