Image: Mike Mozart
By Brian Nelson, CFA
We’re reiterating our bullish view on newsletter portfolio holding Microsoft Corp. (MSFT) following its fiscal second-quarter report released January 25. We’re huge fans of the company’s strong economic moat, and while its net balance sheet cash will erode somewhat in light of its proposal to acquire Activision (ATVI), the company’s cloud opportunity and suite of recurring-revenue services makes for one attractive free-cash-flow generating powerhouse. The market may have wanted more from Microsoft’s fiscal second-quarter report, ended December 31, 2021, but it was solid across the board, in our view. We’re sticking with our $342 per share fair value estimate at the time of this writing.
The headline numbers in Microsoft’s fiscal second quarter were nothing short of fantastic. Revenue advanced 20% while operating income increased 24%, both on a year-over-year basis. Net income and diluted earnings per share jumped 21% and 22% year-over-year, respectively. Microsoft Cloud revenue leapt 32% from the same period last year thanks to 46% expansion in Azure and other cloud services performance. The growth rates across the board were phenomenal, and while we don’t expect this torrid pace to continue, investors must understand that the digital economy is here to stay and that technology as a percentage of gross domestic product will continue to increase. Microsoft remains at the forefront of the innovation curve and at the heart of long-term digital technology economic expansion.
Microsoft has generated net cash from operations of $39 billion through the six months ended December 31, up from $31.9 billion in the year-ago period. Capital spending came in at $11.7 billion over the same period, up from $9.1 billion in the same six-month period last year, but it is clear free cash flow generation remains quite robust and far more than the $8.9 billion in cash dividends it paid during the first half of its fiscal year. The company ended the year with $125.4 billion in total cash and cash equivalents, $5 billion in short-term debt, and $48.3 billion in long-term debt. Its all-cash deal for Activision will eat up much of its net cash position, but it’s difficult to argue with Microsoft’s dominance across the board and its efforts to become a video game giant.
We’d be stretching to say that we didn’t like Microsoft’s performance in its fiscal second quarter. Though it is only reasonable to expect growth rates across several of Microsoft’s divisions to slow from here, we continue to believe in the company’s tremendous free cash flow generation as it rebuilds its net cash position following the expected completion of the Activision deal (note the deal has not been consummated yet and that there remains a possibility it may not be completed). Microsoft’s dividend growth coverage remains stellar, and we see its competitive position only strengthening. Shares are trading at ~$300 each, modestly higher in pre-market trading January 26.
{Note updated 6:56am January 26 to include pre-market trading activity.]
Microsoft’s Fiscal Second Quarter Presentation Slides (pdf) >>
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Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, BITO, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson’s household owns shares in HON, DIS, HAS, NKE. Some of the other securities written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.