Microsoft, which in 2018 regained the title of largest company by market cap, is set to report FY Q2 earnings Wednesday after the close.
How the tables have turned.
Less than six months ago, a look at the top-three companies by market capitalization would have shown Apple (AAPL) in first place with its then $1 trillion market cap, followed by Amazon (AMZN) and Google parent Alphabet (GOOG, GOOGL).
At that time, Microsoft (MSFT), once the poster child for huge U.S. tech companies and the first public company to reach $500 billion in market cap way back in 1999, sat in fourth place on the list. However, that was before a Q4 that proved very harsh on the three leaders, and now MSFT once again holds first place on the leaderboard.
It’s not as though MSFT stock didn’t have its struggles toward the end of 2018. Like most of the tech sector, MSFT found its shares under pressure. However, they generally held up far better than rivals, perhaps in part because MSFT reported fiscal Q1 earnings for the quarter ended in September that easily beat analysts’ estimates, while the AMZNs and AAPLs of the world generally disappointed investors with their guidance in the same period. MSFT shares fell 11% between Sept. 30 and the end of the year, but were up about 3% so far in 2019 through late Tuesday. AAPL shares, in contrast, fell 30% in Q4.
MSFT comes back with fiscal Q2 earnings on Wednesday after the close. The company is expected to report earnings per share of $1.09, according to third-party consensus estimates, up from $0.96 a year ago. Analysts expect the company to report fiscal Q2 revenue of $32.49 billion, up 12.4% from the same quarter a year earlier.
Though MSFT’s cloud business is likely to once again draw the most headlines when the company reports, its biggest segment is More Personal Computing—which includes Windows, devices, gaming products like Xbox and search ads. In fiscal Q1, this business line produced $10.7 billion in revenue, up 15% year over year, beating analysts’ estimates. Whatever else MSFT does, the health of this segment might seem to loom large in Q2.
Another business that throws major weight around at MSFT is its Productivity and Business Processes segment, which includes Office, LinkedIn and Dynamics. This segment accounted for just over $9.8 billion in Q1 revenue, up 19% year over year.
The Intelligent Cloud segment, which includes server products and cloud services, grew 24% in Q1 with $8.6 billion in revenue, according to the company’s Q1 release. MSFT’s biggest growth driver, according to some analysts, is its Azure public cloud, which competes with Amazon Web Services (AWS). Azure saw a slight slowdown in growth in Q1, to 76% from 89% in Q4. Any further slowing of growth in Q2 might bring up some questions, but when you’re dealing with growth levels this high, comparisons might start to get tough. MSFT hasn’t broken out revenue for Azure, so it’s hard to say exactly how big an impact it’s having on the overall business. MSFT said FY Q1 Azure growth was in line with its own expectations.
Because Azure is in the spotlight, MSFT shares sometimes move quickly after earnings based simply on results of this business, so investors might want to consider closely watching this particular number. MSFT shares fell 2% in the immediate aftermath of fiscal Q1 earnings as investors absorbed the lower Azure growth number, but then jumped back as investors pored over the rest of the company’s data.
Microsoft says it has a hybrid cloud strategy, which includes sales of on-premises server products as well cloud services through Azure. Some analysts say this helps position MSFT well to take advantage of the overall transition toward cloud computing. As of fiscal Q1, Azure still appeared to be somewhat behind AWS in terms of percentage of cloud market sales, according to analysis firms quoted by the media. If Azure growth continues to slow, that could very well become a key focus of Wednesday’s conference call.
One thing to consider watching is whether MSFT continued to increase Azure bookings during the quarter, as it said it did in fiscal Q1. This can be an imprecise way of measuring demand growth.
However, investors might risk getting too wrapped up in Azure and miss other parts of the business. Fiscal Q1 saw LinkedIn revenue grow 33%, while gaming revenue rose 44%. Also, Surface revenue, which had been stagnant for a while, grew 14% in fiscal Q1, in part because of new models becoming available.
Since MSFT is now the biggest company by market-cap in the world (at least for the moment), management’s insight on the global economy might be an important aspect for investors to monitor in the earnings call. Other companies reporting so far this earnings season have said softness in China’s economy is affecting their business, so it might be worth listening to see if MSFT saw any impact from this, as well.
As of Tuesday afternoon the day before the earnings release, options traders have priced in a 4.2% ($4.34) stock move in either direction around the coming earnings release, according to the Market Maker Move™ indicator on the thinkorswim® platform.
Weekly option activity has concentrated on the call side, notably at the 105, 108 and 110 strikes. Put activity has been higher at the 100 strike. Implied volatility was at the 49th percentile as of Tuesday afternoon.
Note: Call options represent the right, but not the obligation, to buy the underlying security at a predetermined price over a set period of time. Put options represent the right, but not the obligation, to sell the underlying security at a predetermined price over a set period of time.
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