Microsoft slides 3% as results fall short of lofty valuation

Microsoft reported strong Q1 earnings, surpassing expectations with EPS at $3.30, above the consensus estimate of $3.11, and revenue reaching $65.59 billion, exceeding the anticipated $64.51 billion. The company’s cloud business, especially Azure, played a pivotal role in this outperformance, as Microsoft Cloud revenue climbed to $38.9 billion, slightly ahead of the $38.11 billion estimate, with Azure alone seeing 34% revenue growth in constant currency, 12% of which was driven by AI contributions. Microsoft's performance underscores its leadership in AI innovation, with CEO Satya Nadella emphasizing that AI is reshaping business operations across sectors.

Shares of MSFT are sliding lower in after hours trade. This is primarily due to some concerns around valuation as the stock was trading at 35x forward earnings. The results, while impressive, fell short of this lofty price tag and is leading to some profit taking.

In segment performance, Microsoft’s Intelligent Cloud division generated $24.09 billion in revenue, marking a 20% year-over-year increase, largely due to a 23% boost in server products and cloud services, led by Azure’s strong performance. The Productivity and Business Processes segment, encompassing Microsoft 365 and LinkedIn, brought in $28.32 billion, reflecting 12% growth as Microsoft 365 Commercial saw a 13% revenue increase, while Dynamics 365 grew by 18%. More Personal Computing revenue, including Xbox and Windows, reached $13.18 billion, with Xbox content and services revenue up by 61% due to the recent Activision acquisition.

Microsoft’s Q2 guidance calls for continued momentum, with anticipated Intelligent Cloud revenue between $25.55 and $25.85 billion, largely driven by Azure, which is expected to grow by 31%-32% in constant currency. Additionally, the Productivity and Business Processes segment is forecasted to generate $28.7-$29 billion, with Microsoft 365 maintaining a steady growth trajectory. In More Personal Computing, revenue guidance falls between $13.85-$14.25 billion, driven by a more strategic approach within its consumer businesses like Gaming and Search.

Operating expenses remained an area of focus, with Microsoft’s Q1 gross margin slipping slightly due to rising service costs, pushing cost of revenue to $20.10 billion, a 23.3% increase. Operating income reached $30.55 billion, ahead of the $29.21 billion consensus, as Microsoft managed to balance its capital expenditures, which totaled $14.92 billion, slightly above the expected $14.55 billion. Capital expenditures for Q2 are expected to rise further to support cloud and AI demand, with a portion directed toward long-term assets for sustained AI-driven growth.

AI continued to be a key growth engine, with Azure AI contributing 12 points to Azure’s Q1 revenue growth. Microsoft 365 Copilot and OpenAI-powered offerings are seeing widespread adoption across sectors, with AI-powered features increasingly integrated into Microsoft 365 products, such as Copilot, which aims to streamline workflows and enhance productivity across enterprises. Despite capacity limitations affecting short-term growth, Microsoft remains optimistic about AI as a long-term revenue driver.

Looking at Microsoft’s strategic spending, capital expenditure is set to increase sequentially, indicating the company’s commitment to scaling AI infrastructure, which is expected to yield robust returns over time. CFO Amy Hood highlighted that cloud and AI spending on assets with long-term lifespans would support monetization opportunities for years to come, balancing short-term pressures with anticipated future returns. This investment outlook aligns with Azure’s growth, as Microsoft readies to add substantial Azure revenue in Q2, bolstered by AI-driven capacity expansion.

In summary, Microsoft’s Q1 earnings report reflects solid growth across segments, with Intelligent Cloud and Azure leading the charge, driven by strong AI adoption. The company’s proactive approach to capital allocation and capacity scaling in AI services underscores its commitment to sustaining growth in an increasingly competitive landscape. With promising Q2 guidance, Microsoft aims to build on its AI momentum, positioning itself as a transformative force in the enterprise technology and cloud computing markets.