Microsoft Cloud Confidence Warrants A Price Target Boost At Deutsche Bank

Deutsche Bank upped his price target on Microsoft Corporation MSFT shares to $75 following upbeat tone from the company on cloud computing/technology at a meeting with Deutsche Bank analysts.

The Cloud

The commercial cloud (Office 365, Azure, Dynamics Online) business of Microsoft is now at a $13 billion run-rate, or 14 percent of the overall revenue mix (20 percent with the inclusion of LinkedIn).

“The color on Azure was positive, it feels like MSFT is nearing the tail-end of its data center capacity “catch-up” phase,” lead analyst Karl Keirstead wrote in a note.

Microsoft reaffirmed guidance for “material improvement” in cloud gross margins in FY 2017 and again said that the sequential change could be lumpy, raising the possibility of a sequential decline in the second quarter due to the mix. The analyst models a modest sequential decline in cloud gross margins to 47 percent in the second quarter.

Rating and Justification

Keirstead, who has a Buy rating on Microsoft, noted that the server product demand drivers should offset the tepid Windows server transactional business.

Meanwhile, the meetings suggested that Office ARPU and margins still appear to be trending up, and the better-than-expected PC industry data points bode well for Windows business.

Further, Microsoft may need to restate historical financials when it adopts the new revenue recognition accounting standards in FY 2018, which for Microsoft begins in calendar 3Q17. But, this should be a non-event for most investors as the focus is on cash flow.

“Because cash flow is relatively unaffected, MSFT will ‘pivot’ to a greater focus on cash flows in 2HF17. In our view this is a good thing, as the Street increasingly values MSFT on a FCF basis and because the OCF margin trend line is strong and underappreciated,” Keirstead highlighted.

Valuation

On the valuation front, the analyst said Microsoft shares are not cheap at 15x his CY 2017 estimated FCF and 21x adjusted EPS, and they could take a breather in the mid-60s. However, Keirstead still don’t think that the stock is a consensus long.

Keirstead raised his price target to $75 from $70, while shares are up 4 percent since the U.S. election. At last check, shares of Microsoft were up 0.19 percent to $63.10.