Microsoft delivers an earnings beat but misses where it matters most
Microsoft couldn’t shake the bear thesis with its fiscal 2025 second-quarter numbers Wednesday, causing the stock to fall more than 5% in extending trading. Despite beating top-line and bottom-line estimates, the software giant’s disappointing cloud revenues and soft guidance renewed concerns its AI spending is not generating sufficient returns. Revenue increased 12% year over year to $69.6 billion in its fiscal 2025 second quarter, beating the Street consensus estimate of $68.78 billion, according to data from LSEG. Earnings per share increased 10% from last year to $3.23, ahead of EPS estimates of $3.11, LSEG data showed. Microsoft Why we own it : Microsoft is a core backbone of global productivity thanks to its Office 365 suite and hybrid cloud platform Azure. The company is also proving itself to be a key provider of artificial intelligence tools due, in part, to its large investment in OpenAI, the startup behind ChatGPT. We also like what it’s doing in the video gaming industry as looks to grow recurring revenue streams. Competitors : Amazon , Alphabet and Salesforce Weight in portfolio : 2.75% Most recent buy : Aug. 5, 2024 Initiated : Dec. 4, 2017 Bottom line Overall it was a solid quarter. The company beat analysts’ estimates on several line items and posted better-than-expected operating margins. However, Microsoft did not meet the bar where it counts most: Azure cloud revenue growth. There were some notable achievements in the quarter. For its AI business, the annual revenue run rate exceeded $13 billion and contributed 13 percentage points to Azure revenue growth, up from 12 points last quarter. But the results still failed to meet the mark due to non-AI cloud-related execution issues, which is something extremely rare for this high-quality company. Plus, the bullish case around an Azure revenue growth reacceleration in the second half of the year stumbled when management provided the same guidance it gave last quarter. As for what Chinese startup DeepSeek’s low-cost AI model means for Microsoft, CEO Satya Nadella sounded quite bullish on the opportunities, commenting that “as AI becomes more efficient and accessible, we will see exponentially more demand.” He later added that when the cost of cloud computing falls, inference computing prices drop too, allowing customers to consume more with more apps written. “When I reference these models that are pretty powerful, it’s unimaginable to think that here we are in sort of beginning of ’25, where on the PC you can run a model that required pretty massive cloud pretty massive cloud infrastructure” Nadella explained. “So that type of optimization means AI will be much more ubiquitous, and so therefore for a hyperscaler like us, a PC platform provider like us, this is all good news as far as I’m concerned.” This may sound promising for the future, but there’s still a lot of uncertainty about DeepSeek’s impact. Until more is known, the market wants to see faster cloud revenue grow to justify the billions of dollars the company is investing to scale AI infrastructure and Microsoft simply did not deliver this quarter or with its outlook. We expressed some concerns about Microsoft last week during our Monthly Meeting, and while it’s hard to depart from such a dominant company, this earnings report did not change our view. We reiterate our 2 rating and maintain our $500 price target. MSFT 1Y mountain Microsoft’s 1 Year Return Quarterly results Productivity and business processes reported revenue and operation income that exceeded the consensus forecast with double-digit percentage growth, though the gross margin percentage declined slightly due to continued scaling of AI infrastructure. Microsoft 365 commercial cloud revenue growth increased 15% year over year, with seat growth up 7%. Microsoft 365 consumer cloud revenue growth increased 8% year over year, with subscribers increasing to 86.3 million from 84.4 million one quarter ago. LinkedIn revenue grew 9%, with strength seen in all its lines of business. Dynamics 365 revenue increased 18% year over year, driven by growth across all workloads. Intelligent cloud was a miss on both revenues and operating income, and gross margins compressed (as expected) due to the scaling of its AI infrastructure. We would have preferred to see stronger results from its cloud computing business Azure. Total revenue increased 31% year over year, beating the FactSet consensus estimate of 30.2%. However, the constant currency (cc) result gives a clearer picture because it strips out the effects of changing foreign exchange rates. On a cc basis, revenue increased 31% as well, in line with management’s guidance of 31% to 32%, but that was below the FactSet consensus estimate of 32%. Looking closer, while the AI part of the business remains capacity constrained, management pointed out growth in its non-AI services as slightly lower than expected due to what they described as “go to market execution challenges” with customers reached through “scale motions,” meaning partners and other indirect sales methods. The more personal computing segment posted better-than-expected results, with revenues flattish and a nice uplift in operating income and gross margin thanks to increased sales in higher-margin businesses and improvements in gaming, search, and news advertising. In the quarter, Microsoft saw growth in its Windows OEM, Xbox content and services, and search and news advertising businesses while devices, gaming, and Xbox hardware revenues declined. Guidance Management’s revenue outlook for its fiscal 2025 third quarter was lower than what analysts expected across all key lines. The biggest miss came from the intelligent cloud segment, where management guided Azure revenue growth of 31% to 32%. To us, this is stabilization and not the reacceleration management previously said would begin in the second half of the fiscal year. Sure, some of the miss could be explained by an increase in headwind assumptions from the strengthening U.S. dollar. The company now sees FX to decrease total revenue growth by 2 percentage points. That’s an extra $1 billion versus prior expectations. However, if we sum the midpoint of each guide and add back in $1 billion, it was still a revenue miss versus the FactSet consensus estimate. For a stock trading at 32 times forward earnings-per-share estimates, you have to hit your numbers. The strong dollar does help on the expense side, decreasing the cost of goods sold (COGS) and operating expense growth by 2 percentage points and 1 percentage point, respectively. Also, it now expects fiscal year 2025 operating margins to be up slightly year over year and that’s slightly better than expected. Microsoft expects quarterly spend in the third and fourth quarters to stay at the same levels as the second quarter. For fiscal year 2026, Microsoft expects the capex growth rate to be lower than fiscal year 2025, with spending shifting from long-lived assets like infrastructure, power, and land back to short-lived assets like CPUs and GPUs, which the company says are more correlated to revenue growth. (Jim Cramer’s Charitable Trust is long MSFT. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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Satya Nadella, CEO of Microsoft, speaking on CNBC’s Squawk Box outside the World Economic Forum in Davos, Switzerland on Jan. 22nd, 2025.
Gerry Miller | CNBC
Microsoft couldn’t shake the bear thesis with its fiscal 2025 second-quarter numbers Wednesday, causing the stock to fall more than 5% in extending trading. Despite beating top-line and bottom-line estimates, the software giant’s disappointing cloud revenues and soft guidance renewed concerns its AI spending is not generating sufficient returns.