Microsoft Q4 Earnings: It's All About The Cloud Now

If there’s any company that can demonstrate the value of diversification in a period of unprecedented economic turmoil, Microsoft Corporation MSFT is arguably one of them.

Like most businesses, the software giant took a few sharp hits to some of its core segments during the COVID lockdown earlier this year. But in the end, other segments in MSFT’s vast portfolio of services propelled the company to big growth in its fiscal Q3 reported in April, likely stunning analysts and investors expecting positive yet tempered results. 

As MSFT CEO Satya Nadella told analysts in last quarter’s conference call, the COVID-19 pandemic brought “two years’ worth of digital transformation in two months.”

Although nobody can really say just how long the pandemic will last, we do know that it’s radically reshaping the way people ‘work’ and how businesses ‘live.’ And to this, Nadella boldly claims that MSFT is “the only” one-stop solution to help businesses sustain their viability in these unusually tough times.

As MSFT reports fiscal Q4 earnings Wednesday after the close, will the results prove his claim (at least for this last quarter)? As COVID case counts rise once again, are businesses going to flock to MSFT’s suite of products to help get through the pandemic’s debilitating effects?

FIGURE 1: PRE-EARNINGS PULLBACK? Shares of Microsoft (MSFT—candlestick) have been following the Technology sector (IXT—purple line) in terms of direction although slightly underperforming the sector at times. Shares have pulled back slightly which could be due to uncertainty around upcoming earnings. Data source: NASDAQ, S&P Dow Jones Indices. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Microsoft’s Intelligent Cloud Overtakes All Other Segments

MSFT has three major segments: Intelligent Cloud, Productivity and Business Processes, and More Personal Computing.

Among the three, the Intelligent Cloud unit—which includes Azure, GitHub, SQL Server, Windows Server and other enterprise services—saw the biggest growth in fiscal Q3, posting $12.3 billion in revenue, up 27% year over year.

For the coming reporting quarter, the company expects revenue for the unit to be between $12.9 billion and $13.15 billion, according to MSFT CFO Amy Hood. About 80% of this is expected to come from existing Azure workload contracts, while Enterprise Services is expected to make up the rest of it.

Azure has often been the biggest focus on earnings day, and could be again when MSFT steps up to the line of scrimmage after Wednesday’s close. Last time out, Azure sales rose 59%. Its growth has been in the high-50’s and low-60s the last four quarters, and analysts continue to expect strong gains due to more people working at home. This trend means companies tend to need more computing power to support their far-flung employees. Growth in the MST cloud was stronger than analysts had expected in fiscal Q3.

The Productivity and Business Process segment experienced the sharpest slowdown in fiscal Q3 due to declines in LinkedIn ad revenue and licensed software revenue from small and mid-sized businesses. The segment brought in $11.7 billion last quarter (Q3), 15% year over year growth, as compared to Q2, which saw slightly higher growth of 16% year over year.

For MSFT’s Q4 results in this unit, Hood provided guidance of between $11.65 billion and $11.95 billion; 80% of which is expected to come from existing contract and agreement renewals. Hood noted that revenue from transactional licensing and LinkedIn advertising remains sensitive to the current economic environment.

If you read our preview for last quarter’s MSFT earnings, you probably remember that MSFT revised guidance due to a supply lag in its More Personal Computing segment. The big story here is Xbox. More time stuck at home can sometimes translate into more gaming time (as parents know all too well).

Consoles tend to be seasonal items; the new Xbox console isn’t slated for release until next holiday season. But that didn’t stop console or gaming demand, as Xbox, according to CEO Nadella, saw “all-time record engagement.” Xbox sales grew 2%. Compare this to the previous quarter, which saw sales decline by 11%, according to CFO Hood.

Overall, this segment saw year-over-year revenue growth of 3% last quarter, or $11 billion. For the coming reporting period, Hood gave guidance between $11.3 billion and $11.7 billion.

As businesses began reopening this quarter, Hood noted that growth rates in the coming reporting period may be impacted. However, given the likelihood that ‘remote work’ may become a more permanent fixture as businesses across some states are once again ‘reclosing,’ MSFT appears to be in a position of strength—providing a one-stop solution for home-based work and home-based entertainment.

What Analysts Are Saying

Since reporting its earnings for FY Q3, MSFT shares jumped as much as 21.7%, pulling back a few points as investors await Q4 results. With the S&P 500 Index (SPX) down slightly year to date, the Technology sector is up nearly 50%, with Software topping all other industries in Tech.

“We increasingly view MSFT as likely benefiting more from the surge in telecommuting than we had expected, especially the cloud...versions of Office and related Teams and SharePoint apps for collaboration,” research firm CFRA wrote in a recent report.

CFRA sees MSFT’s greatest risks stemming from the prolonged impact of COVID-19, but noted that the company’s strong balance sheet may offer “more downside cushion than most large-cap stocks in any sector.”

MSFT Earnings And Options Activity

MSFT is expected to report adjusted EPS of $1.37, flat vs. the prior-year quarter, according to third-party consensus analyst estimates. Revenue is projected at $36.5 billion, up 8.2% from a year ago. The company has guided for fiscal Q4 revenue of between $35.85 billion to $36.80 billion.

That guidance would represent relatively slow revenue growth, historically, for MSFT, and might have weighed a little on shares the last time MSFT reported. So one thing to maybe get a sense of Wednesday is whether the company becomes more aggressive in its outlook.

Options traders have priced in a 4.2% stock move in either direction around the coming earnings release, according to the Market Maker Move™ indicator on the thinkorswim® platform.

Put options have been active at the 200 and 195 strikes, while call option activity has been heaviest at the 215 and 220 strikes. Implied volatility was at the 28th percentile as of Monday morning.

Note: Call options represent the right, but not the obligation, to buy the underlying security at a predetermined price over a set period of time. Put options represent the right, but not the obligation, to sell the underlying security at a predetermined price over a set period of time. 

Photo by Franck V. on Unsplash

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