Microsoft on Barron’s

This weekend’s Barron’s had some kind words for Satya Nadella and his leadership of Microsoft (MSFT). The company’s turnaround has been impressive. I encourage you to read the whole thing but I wanted to highlight this section which argues that analysts maybe underestimating MSFT’s earnings potential:

For the present, however, investors are still treating Microsoft like a traditional software company. The stock trades at 19.5 times fiscal 2016 earnings estimates, versus 80 for cloud-based Salesforce.com (CRM). And the forecasts are conservative. Analysts expect Microsoft’s sales and profits to be flat this year at $93 billion and $22 billion, respectively. Boosted by an aggressive buyback program, earnings per share could still grow 5%. Wall Street expects EPS to rise another 13% in fiscal 2017, to $3.13.

Moerdler is far more bullish. He says that $3.84 is more likely in fiscal 2017 and that analysts are underestimating the growth of Azure and overlooking Microsoft’s Office transition.

The Street’s more conservative numbers are an opening for stock gains. “It creates a big opportunity for Microsoft to ‘beat and raise,’ ” says Moerdler. Indeed, the stock jumped 10% in October after Microsoft reported September-quarter EPS of 67 cents, versus a 58-cent estimate. In April, Microsoft also gained 10%, on a better-than-expected quarter.

Aside from Azure, analysts are also missing the boat on Office, the popular productivity software that includes Word, Excel, PowerPoint, and Outlook. Office has been moving to a subscription model called Office 365, which already has 18 million consumer subscribers. About a quarter of the company’s corporate users have transitioned to the program, too.

(…)

By some math—counting the subscription Office business, Skype, Xbox, and Azure—Microsoft is already the world’s largest cloud company, with annualized revenue close to $10 billion. Microsoft has said its “commercial cloud”—Azure plus commercial Office and other business applications—will be a $20 billion annual business by 2018.

Bullish Microsoft investors, including Bonavico, think the opportunity is best viewed through the lens of free cash flow. Free cash accounts for the fact that, with subscriptions, the recognition of revenue trails the actual receipt of cash. David Pearl, co-chief investment officer at Epoch Investment Partners, thinks Microsoft will generate $3.49 in free cash flow in 2017 and $3.98 by 2018. At 18 times, he gets to a price of $72 in less than two years. And that’s without giving Microsoft any credit for the roughly $8 in net cash per share on its balance sheet. Epoch, which has $42 billion in assets, owns Microsoft stock worth $830 million.

Microsoft’s fiscal year ends in June, but we can translate their earnings into calendar year figures. The company will probably earn about $2.60 per share for 2015 which is up from $2.48 per share last year. However, that can ramp up to $2.92 per share for calendar year 2016. Their earnings have basically flatlined for the past few years but now appear to be heading upward.

Posted by on December 21st, 2015 at 11:55 am


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