Simulated Dividend Growth Newsletter portfolio idea Microsoft turned in a solid fiscal 2018 fourth quarter report. The company continues to throw off tremendous amounts of cash even as it continues to invest materially in future growth opportunities.
By Kris Rosemann
Software giant and simulated Dividend Growth Newsletter portfolio idea Microsoft (MSFT) continues to throw off significant amounts of free cash flow. Fiscal 2018 fourth quarter results were released July 19 and revealed 3% growth in free cash flow generation for the full year period, even after a 43% increase in capital spending. Its Dividend Cushion ratio sits at an impressive 3.5, and cash dividends paid in fiscal 2018 of $12.7 billion were well-covered by the $32.3 billion in free cash flow generated in the year (share repurchases totaled $10.7 billion in the year). Net cash of $57.5 billion at the end of fiscal 2018 (up from $46.8 billion a year ago) only adds to our conviction in this long-term dividend growth idea. Shares yield ~1.6% as of this writing, and we’ve raised our fair value estimate to $112 per share following the strong quarter.
Microsoft continued its strong top-line momentum in its fiscal fourth quarter as revenue grew 17% from the year-ago period. Commercial cloud revenue leapt 53% to $6.9 billion in the quarter, and Azure revenue came up just short of its 11th consecutive quarter of 90%+ growth with a reported year-over-year increase of 89% in the period, which helped drive 26% expansion in server products and cloud services revenue. Its ‘More Personal Computing’ segment reported a 17% revenue increase from the comparable period of fiscal 2017 thanks to strength in gaming, services, and Surface revenue. Momentum at LinkedIn continued with 37% year-over-year revenue growth, but the business remains an insignificant portion of its overall financial makeup at this point, even as engagement growth is encouraging.
Operating income at Microsoft in its fiscal fourth quarter leapt 35% from the year-ago period thanks in part to disciplined G&A spending, lower restructuring costs, and an expansion in gross margin to 67.6% from 67% in the comparable period of fiscal 2017. Gross margin expansion was boosted in part by the continued growth of higher-margin commercial cloud revenue as well as strength in the ‘More Personal Computing’ segment. Net income grew only 10% in the period on a year-over-year basis due to unique tax consequences in the year-ago period, but the aforementioned strength in free cash flow generation was boosted by non-cash tax charges added back into cash from operations, which came in at $43.9 billion in fiscal 2018, 11% higher than fiscal 2017.
Looking ahead to fiscal 2019, management expects another year of strong revenue growth in its commercial business, though an increase in larger long-term commercial agreements could lead to higher levels of volatility in commercial bookings and unearned revenue. The ‘Productivity and Business Processes’ segment is projected to continue growing at a double-digit rate thanks to strength in Office 365, Dynamics 365, and LinkedIn. Ongoing improvement in Microsoft’s commercial cloud gross margin is expected, though the pace of expansion is expected to slow relative to that of fiscal 2018. Management also anticipates slight operating margin growth in fiscal 2019 despite ongoing investment in commercial cloud, LinkedIn, gaming, and AI expected to lead to operating expense growth of roughly 7%.
In the first quarter of fiscal 2019, Microsoft expects its ‘Productivity and Business Processes’ segment to report revenue of $9.25-$9.45 billion, or growth of ~13%-15% from the first quarter of fiscal 2018, thanks to expected double-digit growth in Office Commercial and Dynamics and continued strength at LinkedIn. Its ‘Intelligent Cloud’ segment revenue for the first fiscal quarter is projected to grow to $8.15-$8.35 billion, roughly 18%-21% higher than the year-ago period, driven in part by Azure growth, which should reflect ongoing and balanced strength in its consumption-based services. ‘More Personal Computing’ segment revenue is projected to be in a range of $9.95-$10.25 billion in the first fiscal quarter, representing growth of ~6%-9% on a year-over-year basis.
We expect to continue highlighting Microsoft in the simulated Dividend Growth Newsletter portfolio for the foreseeable future, and it remains one of our top dividend growth ideas on the market today. Its yield may leave a bit to be desired at current prices, but this is in part a result of the equity’s tremendous performance of late. The cash-rich company has all the markings of a top-notch dividend idea, and we love its thirst for innovation as it continues to expand its presence in large and growing markets. Shareholders must be pleased with the fruit of the company’s early investments in next-generation technology such as the intelligent cloud and intelligent edge, which continued with its recent win over Alphabet (GOOG, GOOGL) and others for the purchase GitHub, “Microsoft Wins GitHub Over Alphabet.”
—–
Valuentum members have access to our 16-page stock reports, Valuentum Buying Index ratings, Dividend Cushion ratios, fair value estimates and ranges, dividend reports and more. Not a member? Subscribe today. The first 14 days are free.
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.