Microsoft's fourth-quarter earnings report last year exceeded expectations, with cloud growth still needing to accelerate. After-hours trading saw a decline of over 2%. | Earnings Report

On Tuesday, January 30th, after the U.S. stock market closed, Microsoft, the technology giant leading the hot trend of precision betting on generative artificial intelligence, released its financial report for the second quarter of the 2024 fiscal year (i.e., the fourth quarter of the 2023 calendar year), which is also the first financial report since the acquisition of Activision Blizzard.

This financial report exceeded market expectations in terms of revenue, EPS (earnings per share), and cloud business revenue growth, among other indicators. However, Microsoft's stock fell more than 2% after hours, briefly turning positive before the earnings call. Some analysts believe that this is because the positive impact of AI may have already been fully reflected in the stock price.

On Tuesday, Microsoft closed down 0.3%, temporarily deviating from the historic high set yesterday. With the market's expectation of a surge in AI-driven cloud revenue, Microsoft, as a component of the Dow Jones Industrial Average, surpassed Apple to become the highest-valued company in the U.S. stock market, with a market capitalization exceeding $3 trillion.

In 2023, Microsoft's stock price rose by 57%, outperforming the 24% increase in the SPDR S&P 500 Index, and joined NVIDIA, the chip giant, as one of the biggest beneficiaries of AI trading. Since 2024, Microsoft has risen by about 9%, outperforming the 3% increase in the SPDR S&P 500 Index.

Wall Street is full of confidence in Microsoft's stock price prospects. Before the release of the financial report, all 50 analysts unanimously recommended buying Microsoft, with only four giving a "neutral" hold rating and no one recommending selling. The average target price is around $443, representing an 8% potential increase.

Microsoft achieves its highest quarterly revenue growth in nearly two years and sets a new revenue record for five consecutive quarters

The financial report shows that Microsoft achieved adjusted earnings per share of $2.93 and revenue of $62 billion in the heavyweight holiday shopping quarter at the end of last year, representing year-on-year growth of 33% and 17.6%, respectively. These figures also exceeded Wall Street's expectations of $2.78 and $61.1 billion.

This is Microsoft's best quarterly revenue growth since 2022, mainly due to the increasing adoption of products that incorporate generative artificial intelligence, which effectively stimulates demand for Microsoft's cloud services, accelerating the growth of this core business and winning market share.

Net profit for the quarter increased by 33% year-on-year to $21.87 billion, and non-GAAP net profit increased by 26% year-on-year (23% growth at fixed exchange rates). Operating profit also increased by 33% year-on-year to $27 billion, and non-GAAP operating profit increased by 25% year-on-year (23% growth at fixed exchange rates).According to analysis, Microsoft's quarterly revenue exceeded the previous quarter's record high of $56.5 billion, marking the fifth consecutive quarter of revenue growth driven by the AI boom. However, net profit declined compared to the September quarter, dropping to $22.3 billion.

AI-driven Azure Cloud Revenue Growth of 6%, but growth may not meet expectations

Breaking it down by business segment, the Intelligent Cloud division, which includes Azure, servers, and GitHub, generated quarterly revenue of $25.88 billion, a 20.4% increase from the same period last year ($21.5 billion), surpassing market expectations of $25.3 billion.

Among them, Azure and other cloud services saw a revenue growth of 30%, surpassing market expectations of nearly 28% YoY growth and the previous quarter's 29% growth. This also exceeded Microsoft's previous official guidance of 26% to 27% YoY growth in Azure revenue.

Amy Hood, Microsoft's Executive Vice President and Chief Financial Officer, stated that the strong execution of the sales team and partners drove Microsoft Cloud revenue to $33.7 billion, a 24% YoY increase (22% growth at constant exchange rates).

Microsoft Chairman and CEO Satya Nadella stated that Microsoft has shifted from talking about AI to applying AI on a large scale.

During the conference call, the CFO disclosed that AI drove a 6% increase in Azure revenue, surpassing the 3% proportion in the third quarter of last year. The number of paid commercial cloud users has exceeded 400 million, and customer interest in AI products will lead to increased spending on Microsoft's basic services such as storage and computing power.

Some analysts believe that Microsoft's Intelligent Cloud revenue grew by 18% YoY at constant exchange rates, which is the same growth rate as the previous quarter. Azure revenue growth at constant exchange rates also remained steady. This may disappoint some investors and cause the stock price to decline after hours.

In addition, the Productivity and Business Processes division, which includes Office software, saw a 13% YoY increase in quarterly revenue to $19.25 billion, surpassing the expected $19 billion.Microsoft's More Personal Computing division, which includes the Windows operating system, Surface hardware, Xbox game consoles, and the newly acquired video game company Activision Blizzard, saw a quarterly revenue increase of approximately 19% YoY to $16.89 billion, slightly exceeding expectations.

Analysts believe that the recovery of the personal computer (PC) market has driven the largest revenue growth in four years for the Windows and devices businesses. After completing the acquisition of Activision Blizzard in October last year, Xbox content and services revenue in the fourth quarter of last year jumped 61% YoY.

Microsoft kicks off the "Super Bowl" of tech stock earnings reports, focusing on AI monetization and cost pressures

Microsoft's earnings report has attracted attention not only because of its significant position in the tech industry but also because of its early leadership in the field of artificial intelligence (AI), prompting investors to pay attention to whether Microsoft's massive AI investments, as well as those of similar companies, are showing signs of sustained returns.

Analysts say that Microsoft's investment of $13 billion in OpenAI, the parent company behind the highly popular generative AI model ChatGPT, has made it a leader in the AI race. Its performance will not only determine the overall performance of the software industry this earnings season but also set the tone for AI expectations this year.

At the same time, tech stocks such as Google, Amazon, Meta, Apple, and AMD will all release their earnings reports this week. It can be said that Microsoft has kicked off the "Super Bowl" of earnings reports for large tech companies in the US on Tuesday.

During the earnings conference call, analysts will closely monitor the latest developments in the growth of the Azure cloud division, including customer engagement rates, initial subscription scale, use case prospects, and performance guidance for the next few quarters, especially in relation to the recent launch of the Copilot generative AI tool for consumer and enterprise customers. This is in order to gain insights into Microsoft's prospects for monetizing AI and to understand more about the next stage of AI development.

Investors will also pay attention to the cost pressures brought about by Microsoft's multi-billion-dollar investment in AI. Microsoft previously projected that the gross margin of its cloud business in the fourth quarter of 2023 would be roughly in line with the same period of the previous year, mainly due to increased spending on AI infrastructure to meet growing demand. According to estimates by the London Stock Exchange Group (LSEG), Microsoft's operating expenses for the quarter will see the largest increase in five quarters.Wall Street remains confident in Microsoft, with AI expected to drive revenue growth in the second half of the year

Morgan Stanley analyst Keith Weiss stated in a research report two weeks ago that generative AI has become the top priority for chief information officers (CIOs) of various companies, and Microsoft is in a unique advantageous position, with most CIOs expecting to use Microsoft AI products in the next 12 months.

Brokerage firm Jefferies analyst Brent Thill also predicts that AI will contribute to the growth of Microsoft Azure cloud revenue, as channel surveys indicate strong demand for Azure AI services.

Evercore ISI analyst Kirk Materne reiterated that Copilot is expected to have a greater impact on Microsoft's revenue growth in the second half of 2024:

"Based on our expert discussions, there is significant interest in Copilot. The question is not whether, but when the adoption rate will begin to grow in a more substantial way."

Tyler Radke from Citigroup Research also believes that as customer IT spending budgets improve, the monetization of AI can drive Microsoft's revenue and profit growth to continue accelerating in the coming years.

Dan Ives, the star technology analyst at Wedbush, even bluntly stated that Microsoft and NVIDIA have become the "two torchbearers" of the AI revolution sweeping the market. The surge in Microsoft's core enterprise product customers transitioning to cloud services at the end of last year has already occurred:

"In short, we believe (AI) is Microsoft's 'iPhone moment'. Artificial intelligence will change the trajectory of Microsoft's cloud growth in the next few years, and even make the optimistic performance guidance given by the company's management appear conservative."

Both this analyst and Brad Zelnick from Deutsche Bank have set a target price of $450 for Microsoft, which represents a nearly 10% increase from Tuesday's closing price. The latter pointed out that even among peers, Microsoft's absolute multiples and growth-adjusted multiples are already considered expensive:

"But the good news is that the excitement of artificial intelligence, which drove the surge in tech stocks last year, and the continuously improving backdrop of public cloud, have not yet been fully reflected in the market's consensus pricing of Microsoft 365 productivity platform or Azure cloud business.

The revenue of these two businesses will continue to rise, and the potential for profit margin expansion is greater than expected, providing opportunities for Microsoft to continue to perform well in 2024. Microsoft will maintain healthy double-digit percentage growth in free cash flow in the coming years."