What You Need to Know Ahead of Microsoft's Earnings?

Over the past year, $Microsoft(MSFT)$   shares have gained nearly 13%. Despite hitting an all-time high on July 5 last year, Microsoft's stock has underperformed the Nasdaq 100 index since March, raising questions among investors about whether its substantial investments in artificial intelligence and cloud infrastructure will deliver high returns. Microsoft is set to report its second-quarter earningsaftermarketcloseon January 29 (ET).The results are expected to be crucial in alleviating investor concerns over the company's spending on data centers and AI.

Analysts estimate that Microsoft is projected to report a revenue of $68.82 billion for the second quarter, representing year-over-year growth of 10.97%. Earnings per share are expected to come in at $3.11, marking a 6.31% increase compared to the same period last year. The average price target for Microsoft is $509.03, which implies a 14.18% upside from the current stock price.

Key Points to Watch

According to Microsoft's FY24 results, the company's cloud businesses—comprising Azure, OpenAI, GitHub, and SQL—account for approximately 43% of total revenue. The Productivity and Business Processes segment, driven by the Microsoft 365 suite, contributes around 32% of total revenue. Meanwhile, the Personal Computing segment, which includes Windows, gaming, and search, makes up roughly 25% of the company's revenue.

Cloud Business: Key Driver of Growth Amid AI Momentum

Propelled by AI services, the Intelligent Cloud segment, led by Azure, is expected to remain the primary driver of Microsoft's earnings growth this quarter, although Azure's growth may show signs of deceleration due to data center capacity constraints. Jefferies projects Azure's year-over-year growth at 32%, supported by expanded capacity and improving consumption trends, following the 34% growth reported in the previous quarter. Analysts also anticipate that Azure's growth could reaccelerate in the second half of FY25, driven by enhanced AI capabilities and stable macroeconomic conditions. Given sustained demand for AI and cloud services, capital expenditures are expected to remain elevated this quarter.

Productivity and Business Processes: Revenue is Expected to Approach the Upper Range of Guidance

The Productivity and Business Processes segment continues to see robust growth, with Office 365 and related services serving as the main drivers. Microsoft holds a near-monopoly in the productivity software space, with most third-party applications deeply integrated with Office, resulting in high switching costs for users. On January 17, Microsoft announced its first subscription price hike for Office 365 in 12 years, increasing prices for Home and Personal plans by 30% and 43%, respectively. While the revenue impact of this price adjustment will not reflect in this quarter's earnings, it signals future growth potential. Wells Fargo estimates that revenue for the Productivity and Business Processes segment will reach $28.8 billion (including foreign exchange impacts), approaching the upper range of Microsoft's guidance. Additionally, Jefferies analysts highlight the growth of M365 Copilot as a key area of focus this quarter.

Personal Computing: Challenges and Opportunities Ahead

In addition to the relatively stable market share of Windows, Microsoft's search and devices segments are expected to face challenges in the coming years. Meanwhile, the company's foray into cloud gaming, powered by its Azure platform, positions it to expand its presence in the gaming industry. The acquisition of Activision Blizzard is anticipated to enhance Microsoft's gaming portfolio, bolstering its competitive edge. However, elevated capital expenditures from AI-related investments and the Activision acquisition could exert pressure on profit margins in the short term.

The Stargate Project sparks optimism for Microsoft's AI and data center investments

Donald Trump's recently announced Stargate Project has further elevated investor expectations for Microsoft, given its early investments in data centers and artificial intelligence. The project involves a joint venture between OpenAI, SoftBank, and Oracle to establish Stargate, which aims to significantly invest in AI infrastructure. With an initial funding of $100 billion, the project's total investment is expected to scale up to $500 billion over the next four years. JPMorgan analyst Jack Atherton highlighted that this initiative deepens Microsoft's partnership with OpenAI, extending their collaboration through 2030.Microsoft will retain access to OpenAI's intellectual property, revenue sharing, and API exclusivity, while gaining a new "priority purchase" option for additional computational capacity. When asked about Elon Musk's comments suggesting Stargate Project lacked sufficient funding, Microsoft CEO Satya Nadella quipped, "All I know is that my $80 billion is secure."

What Analysts Say?

$Bank of America(BAC)$   has rated Microsoft as a "Buy" with a price target of $510. Analysts expect healthy revenue growth from Azure and Office but noted that feedback from Microsoft's partners indicates this quarter's results are more likely to "meet expectations" rather than exceed them.

Morgan Stanley has assigned a "buy" rating with a price target of $548, citing Microsoft's favorable position to capitalize on the surge in AI-related spending this year. The company recently announced plans to invest approximately $80 billion in data centers to support its AI-focused strategy, including training existing models and launching cloud-based applications for its customers.

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