Microsoft and Intel continue to deliver robust levels of free cash flow, which are core drivers of their respective dividend strength.
By Kris Rosemann
Microsoft’s Commercial Cloud Driving Growth
Simulated Dividend Growth Newsletter portfolio idea Microsoft (MSFT) turned in a solid fiscal third quarter report April 26 as total revenue advanced 16% from the year-ago period, operating income advanced 23%, and diluted earnings per share jumped 36%. Commercial cloud revenue growth of 58% was a key driver of the strong top-line expansion with strong growth in the US, Western Europe, and the UK, and the quarter marked the 10th consecutive quarter in which Azure posted 90%+ revenue growth.
The company’s operating margin expanded by two percentage points from the comparable period in fiscal 2017, which management attributes to focused investments aimed at driving the top line. Free cash flow through three quarters in fiscal 2018 advanced ~9.5% on a year-over-year basis to $24.8 billion despite a meaningful increase in capital spending, easily covering cash dividends paid in the period of ~$9.5 billion and share repurchases of ~$8.4 billion. The company’s balance sheet health remains top-notch as its net cash position at the end of the quarter sat at more than $55.1 billion.
In the fourth quarter of fiscal 2018, Microsoft expects top-line growth to remain strong, with its guidance range implying growth of ~17%-19% on a year-over-year basis. Looking ahead to fiscal 2019, management expects the key drivers of recent performance to remain intact. Execution and a differentiated hybrid position should continue to drive high-teens growth in its server product and cloud services revenue, and commercial cloud gross margin improvement is expected to continue despite revenue mix shift to Azure slowing the rate of improvement.
Microsoft remains one of our favorite dividend growth ideas, and we expect to continue highlighting the idea in the simulated Dividend Growth Newsletter portfolio for the foreseeable future. We currently value shares at $87 each, and the company’s impressive Dividend Cushion ratio of 3.3 gives us confidence in its ability to continue delivering a growing stream of dividends. Shares yield ~1.8% as of this writing.
Intel Raises Guidance After Strong Quarter
After a record year in 2017, Intel (INTC) turned in record first-quarter 2018 revenue, results released April 26, as its top-line advanced 13% from the year-ago period thanks to 25% growth in its data-center business, which now accounts for nearly half of total revenue. Operating income leapt 21% on a year-over-year basis despite gross-margin pressure as disciplined R&D and MG&A spending drove operating margin expansion in the quarter, and net income came in 30% higher than the first quarter of 2017 thanks in large part to a materially reduced tax bill.
Intel’s free cash flow in the first quarter jumped more than 73% from the year-ago period to nearly $3.4 billion, which handily covered cash dividends paid of $1.4 billion and share repurchases of $1.9 billion. The company was also able to make solid headway in improving its balance-sheet health in the quarter as its net debt position fell $0.4 billion from the end of 2017 to ~$12.4 billion.
Management took the opportunity to raise its full year 2018 guidance after the impressive first quarter. Revenue is now expected to be $67.5 billion, up from $65 billion, and non-GAAP operating margin guidance was raised to 31% from 30%. Its non-GAAP earnings per share target was raised to $3.85 from initial guidance of $3.55, and most importantly, Intel’s projection for free cash flow in 2018 was raised to $14.5 billion from $13 billion, suggesting the measure will continue to expand sequentially as first quarter free cash flow annualized comes in at ~$13.5 billion.
We recently raised our fair value estimate for Intel to $54 per share, and given the recent guidance raise, the upper bound of our fair value range is certainly in play for shares. Its PC business continues to navigate a challenging operating environment effectively, and its data-centric business will remain the core driver of growth as it pushes Intel’s cloud transformation forward. The company’s tremendous free cash flow generation (expected to be more than 21% of revenue in 2018) will remain the basis for its attractive dividend profile, which couples a robust Dividend Cushion of 2.4 with a yield of ~2.3%.
We expect to keep Intel as a highest weighted idea in the simulated Dividend Growth Newsletter portfolio, and it remains a core part of the simulated Best Ideas Newsletter portfolio as well. We’re not reading too much into potential production timing issues either.
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.