Is Microsoft's Profit Growth Sustainable?

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"We are concerned that MSFT is generating all operating profit growth in More Personal Computing (MPC), since we don't think this is sustainable," Bachman wrote in a note.

"By our math, even if we exclude the impact of FX, we believe that all of the operating profit growth in the March quarter was driven by MPC, and two-thirds of consolidated operating profit growth was driven by lower opex in MPC," Bachman continued.

Microsoft will announce its fourth quarter results on July 19. While the Street expects EPS of $0.58 on revenue of $22.14 billion, the analyst raised his fourth-quarter EPS estimate by $0.01 to $0.60.

"[W]e think MSFT will make the June quarter, with some upside tension, but guide lower, which seems to be a consistent pattern," Bachman noted.

Although the analyst said the estimates for the June quarter is "ok," he thinks September quarter estimates are "too high."

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Bachman projects September quarter EPS of $0.64, lower than the consensus of $0.69. However, the analyst raised his FY2017 EPS estimate to $2.74 from $2.65, but cut his FY2018 EPS estimate to $2.95 from $3.00.

"We do not believe that LinkedIn will create shareholder value, and we include our pro forma earnings model with LinkedIn. Net, our pro forma FY2018 EPS with LinkedIn is $2.94, compared to our base case of $2.95," the analyst added.

On the last earnings call, Microsoft's CFO indicated that operating profit would grow in FY2017. But, Bachman is skeptical as he sees about 1 percent drop in operating profit in FY2017 and then grow in FY2018.

"For the stock to move meaningfully higher, we believe that operating profit needs to grow," Bachman highlighted.

However, the analyst retained his Outperform rating and target price of $57 saying that "MSFT's valuation is attractive on a FCF basis, but less so on a P/E basis."

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Despite acknowledging that Microsoft is well positioned for the long term, the analyst sees more limited catalysts near term given the impact of mix.

At time of writing, shares of Microsoft were down 0.48 percent to $53.48. The $57 target price implies return of 9 percent over Thursday's close.

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