MSFT Earnings Preview- What investors need to know ahead of the report

Microsoft (MSFT) is set to report its Q4 FY2024 earnings on Tuesday, July 30th, after the market closes. Analysts expect EPS of $2.94 and revenue of $64.3 billion. The sentiment around Microsoft remains strongly positive, particularly with its leading position in AI technology. However, recent global IT disruptions caused by CrowdStrike's faulty software update for Windows have drawn some negative attention. Despite this, investor focus remains on Azure's growth rate, updates on Microsoft's Copilot success, and quantifying AI opportunities for 2024 and beyond.

Azure continues to benefit from multiple tailwinds, including workload growth and a higher mix of GenAI adoption. Spending on GenAI is increasing as a percentage of the workload mix, with Azure taking market share. Checks indicate that enterprises are starting to budget for GenAI-related spending, either through cost savings or budget increases. RAJA maintains an Outperform rating for MSFT, believing it is best-positioned to capitalize on long-term AI tailwinds.

Three major discussion points among investors ahead of the Q4 report are the potential upside for Azure from both AI and non-AI demand, CAPEX trends and returns on AI investments, and Office growth, particularly when Copilot adoption can offset slowing seat growth. Last week, UBS addressed overall Azure demand trends, and recent meetings with AI players like CoreWeave and Cohere suggest positive read-throughs for Microsoft's AI initiatives.

Analysts at Guggenheim have a neutral rating for MSFT, noting divergent risk profiles for Azure, M365 Commercial, and Windows. They see limited upside for Azure consensus estimates, potential risks for M365 Commercial, and achievable estimates for Windows. They believe that further strength in GenAI workloads could benefit Azure, but remain cautious about assuming this trend will continue. M365 Copilot adoption remains an unknown variable, but industry conversations are not particularly encouraging.

Piper Sandler recently bumped MSFT's price target from $465 to $485, maintaining an Overweight rating. They highlight that while it took 13 years for Microsoft Cloud services to reach $100 billion in revenue, the next $100 billion could be added in just three years, driven by critical data center investments. This rapid growth, aided by AI, could help sustain double-digit top-line and bottom-line growth through 2030. They expect cloud revenue, including AI contributions, to grow significantly by FY2026.

TD Cowen expects continued modest upside in Azure, with data points suggesting growth acceleration trends. They have mixed views on O365 Copilot, but believe Street expectations are low and anticipate in-line Office results. Overall, TD Cowen expects a healthy beat on growth and margins, continuing to see MSFT as best-positioned for AI monetization. Despite strong fundamentals and a high probability of beating Q4 consensus, some believe Microsoft's stock is currently overvalued with a limited margin of safety.

TD Cowen expects continued modest upside in Azure, with data points suggesting growth acceleration trends. They have mixed views on O365 Copilot, but believe Street expectations are low and anticipate in-line Office results. Overall, TD Cowen expects a healthy beat on growth and margins, continuing to see MSFT as best-positioned for AI monetization. Despite strong fundamentals and a high probability of beating Q4 consensus, some believe Microsoft's stock is currently overvalued with a limited margin of safety.

Back in April, Microsoft traded higher after posting an impressive Q3 (Mar) report, with its fifth consecutive double-digit EPS beat and notable revenue upside. The software giant provided generally in-line Q4 (Jun) revenue guidance, albeit slightly light of expectations. The quarter marks the first full period to include Microsoft's recent Activision Blizzard acquisition.

Azure was the standout performer, growing +31% in constant currency (CC), surpassing prior guidance of +28% CC. This growth represents a significant improvement from recent quarters where Azure growth had settled in the high-20s. Notably, Q4 guidance for Azure was also strong at +30-31% CC.

Microsoft's PBP and Intelligent Cloud segments both reported revenue above the high end of guidance, while the MPC segment hit the high end. In the commercial sector, bookings rose 31% CC, driven by Azure commitments and an increase in deal size and length. The consumer sector saw slightly better-than-expected PC market demand, benefiting Windows OEM, while ad spend remained in-line. The Gaming segment outperformed expectations due to Activision titles, boosting Xbox content and services. However, Surface demand was slightly lower than anticipated.

Looking ahead, Microsoft expects increased cap-ex spending in Q4 (Jun) and FY25, driven by cloud and AI infrastructure investments. Despite the anticipated rise in cap-ex, the company projects FY25 operating margins to decrease by only about 1 point year-over-year.

Overall, this strong quarter highlighted Azure's significant role, with its performance and large deal acceleration boding well for the cloud segment and future growth.

During the Q3 earnings call, Microsoft management provided detailed guidance for various metrics, anticipating continued top-line growth despite the impact of a stronger U.S. dollar against key currencies. They estimated that exchange rate changes and the stronger dollar would reduce sales by approximately 1%, or around $700 million. Despite this, strong commercial bookings and an increase in the number of Azure contracts were expected.

For the Intelligent Cloud segment, management projected a sales increase of 19-20% year-on-year, driven by the robust performance of Azure. In the Productivity and Business Processes segment, they anticipated growth of 9-11% to $20.2 billion, primarily fueled by higher average check sizes and continued growth in Office 365 subscriptions. The More Personal Computing segment was forecasted to grow 10-13% year-on-year, with significant contributions from Windows OEM and gaming.

Following the acquisition of Activision, management expected gaming revenue to increase by more than 40% year-on-year, a performance similar to Q3 FY2024. Additionally, they indicated that COGS and OPEX would be slightly higher due to accounting changes. However, this increase in expenses is expected to be offset by the strong performance across segments.

Overall, Microsoft projected an operating margin rise, with full-year FY2024 operating margins anticipated to increase by over 2 points year-over-year. This projection takes into account their cloud and AI investments, the impact of the Activision acquisition, and the headwind from the change in useful lives last year.