Microsoft Analysts See 20% Upside Following Across-The-Board Q2 Beat

Microsoft Corporation MSFT reported stellar fiscal-year second-quarter results, sending shares higher.

Microsoft reported quarterly earnings of $1.51 per share, which beat the analyst consensus estimate of $1.32. This is a 37% increase over earnings of $1.10 per share from the same period last year. The company reported quarterly sales of $36.9 billion, which beat the analyst consensus estimate of $35.67 billion. This is a 13.6% increase over sales of $32.471 billion the same period last year.

The Analysts

Wells Fargo Securities analyst Philip Winslow reiterated an Overweight rating on Microsoft and increased the price target from $185 to $205.

Mizuho Securities analyst Gregg Moskowitz maintained a Buy rating and hiked the price target from $180 to $195.

BMO Capital Markets analyst Keith Bachman maintained an Outperform rating and lifted the price target from $165 to $200.

UBS analyst Jennifer Swanson Lowe maintained a Buy rating and raised the price target from $162 to $200.

BofA Securities analyst Kash Rangan reiterated a Buy rating and $200 price objective.

Raymond James analyst Michael Turits reiterated a Strong Buy rating and raised the price target from $192 to $200.

Well Positioned To Capitalize On Multiple Opportunities

Microsoft beat expectations for its top- and bottom-line as well as its business segments, Winslow said.

"Microsoft's consistent, robust performance was again evident in FQ2 results, reinforcing our view that the company is well positioned and capable to capitalize on the multiple opportunities across its diverse business segments," the analyst wrote in the note.

The analyst noted Azure cloud computing service reported 62% year-over-year revenue growth, reinforcing the company's innovation and execution, which is being met with continued demand.

Wells Fargo believes the company can deliver mid-to-high teens EPS and free cash flow per share growth, premised on abating headwinds from a declining PC market, continued robust growth of recurring subscription revenue from Azure and Office 365 and prudent cost controls.

Related Link: Microsoft's Tailwinds Outnumber Headwinds, Analyst Says

Poised For Continued Strong Execution

Microsoft reported a very good second quarter, with healthy upside to revenue, margins and EPS, Moskowitz said. Azure growth accelerated slightly and exceeded estimates and total commercial books grew a robust 30%.

The company raised its operating margin guidance to be up 200 basis points year-over-year, and Moskowitz is looking forward for continued strong execution by Microsoft.

Portfolio Breadth, FCF Generation Impressive

Microsoft's impressive quarter was fueled by very strong growth in gross and operating margins, Bachman said. The fiscal third-quarter guidance suggests year-over-year profit growth will slow to 18-19%, although BMO still sees the growth as impressive.

"While the stock is far from inexpensive, we retain our Outperform rating given the breadth of MSFT's portfolio and FCF generation," the firm said.

MSFT Shares Can Appreciate 15-20%/Year

Healthy Commercial Cloud traction and Windows and Server license growth, boosted by product cycles, helped Microsoft beat revenues and profit forecasts for the quarter, Swanson Lowe said: "We think the strength of Microsoft's business is increasingly well-understood."

UBS sees the company holding its current multiple of 27 times EV/next 12 months free cash flow and grinding steadily higher by 15-20% per year, helped by mid-to-high teens free cash flow growth, Cloud businesses like Azure and premium businesses like Server licensing, which are proving more durable than previously feared.

Cloud-Like In Growth, Legacy-Like In Margins

The metrics that matter to the future outperformed expectations, with the second-quarter results supporting BofA's ongoing thesis that the Street is underestimating Commercial Cloud growth and margin potential, Rangan said. The analyst sees Microsoft not merely as a product cycle story, but a secular growth story.

With Azure and Commercial Cloud driving a majority of recurring revenues and gross profit, the analyst believes Microsoft can rerate higher as EPS accelerates.

"We believe MSFT is unique given that it is cloud like in growth, legacy like in margins, and GAARP like in valuation," Rangan wrote in a note.

Cloud Business Has Edge Over Google, Amazon

Even as revenue growth held steady, EBIT growth accelerated on three points of margin upside, benefiting from strong on-premise software results, cloud gross margin expansion and declines in low-margin gaming consoles, Turits said. The analyst highlighted the growth at different segments:

• Azure: 62%
• Office 365 Commercial: 27%
• LinkedIn: 24%
• Commercial Cloud: 39%, gross margin expanding 1 point from the previous quarter to 67%
• On-premise server: 10%
• Windows OEM: 18%

Raymond James sees Microsoft having advantages over the other two top hyperscale cloud vendors, Alphabet Inc GOOGLGOOG and Amazon.com, Inc. AMZN, due to its strong enterprise relationships and go-to market, and the ability to drive profitability based on "up the stack" products ranging from Office 365 to collaboration, database, analytics, and AI.

MSFT Price Action

Microsoft's stock was trading higher by 2.3% to $173.93 per share at time of publication.