Microsoft (MSFT) stock clocked in some impressive numbers for its latest quarter. Still, it was the upbeat outlook that allowed it to shine as its FAANG peers sagged lower.
Undoubtedly, Microsoft has been a standout winner this earnings season, topping each of the FAANG stocks. Though Apple (AAPL) clocked in a record result, its guidance left investors jittery, leaving Microsoft as one of the last pillars of stability holding up the big tech trade amid this vicious market sell-off.
The Quarter That Saw FAANG Stocks FumbleThe FAANG names are the bluest of blue-chip technology stocks, but they suffered some severe turbulence in recent weeks. Some may think the group deserves to be broken up. Others may believe that the weakness in the group could cause the rest of the market to roll over further.
While it wasn't the best quarter for FAANG, I view Microsoft as the firm that may have single-handedly saved the market from a more vicious decline, perhaps one that would've seen the S&P 500 fall into a bear market.
Microsoft's incredible results give me confidence, not just in the firm moving into a rockier environment, but in all of big tech and even FAANG. Thanks to execution by its brilliant CEO Satya Nadella, Microsoft looks ready to enter rally mode as Wall Street analysts look to upgrade.
While broader market headwinds may delay such a post-earnings rally, I view MSFT stock as a standout play that's well worth its premium price tag. I remain incredibly bullish on Microsoft stock.
Microsoft Stock: Applaud-Worthy Quarter, Great GuidanceIn this type of market environment, where there's fear in the hearts of investors, it's going to take a lot more than an earnings beat to prevent a decline. Microsoft not only clocked in a stellar result that saw Azure flex its muscles, but it also delivered some decent guidance. It was a classic beat and raise at a time when rare misses and downbeat guides have become the norm.
With geopolitical uncertainties, high inflation, ongoing supply chain woes, and a potential recession on the horizon, it's arguable that downbeat guidance would be most conservative. In that regard, Microsoft's constructive guide is a decisive vote of confidence that the firm can continue moving forward, even as the gusts it faces increase in magnitude.
Third-quarter revenues surged 18% year over year. There was notable double-digit growth across numerous segments, but it was Azure's 46% year-over-year growth that was worthy of applause. Indeed, Microsoft Azure is not slowing down anytime soon, with long-term contracts and sizeable deals powering the solid numbers.
Azure Powers Microsoft to Incredible ResultsUndoubtedly, Azure has evolved to become a significant growth driver at Microsoft. While some may doubt the company's growth prospects, the long-time tech darling continues to find new growth levers to pull to resist the growth-eroding effect of corporate aging. Thanks to its CEO Satya Nadella, Microsoft continues to reinvent itself.
The fast-growing cloud space still has many years of high double-digit growth left in the tank. If anything, Azure could take share en route to becoming number one in the public cloud, given the many dedicated customers who desire to stay within the Microsoft ecosystem.
Moving ahead, I'd look for Azure to continue powering Microsoft's high-teens revenue growth as it looks to enjoy the full force of secular tailwinds in the digital transformation trend. It's not just Azure that investors should get excited about, though. Microsoft's Xbox gaming division looks to be in a spot to change the video-gaming world as we know it.
Xbox: The Next Frontier of Growth?In prior pieces, I noted that Xbox Game Pass and Xbox Cloud Gaming were two offerings that would change the video-gaming market as we know it. If the Activision Blizzard (ATVI) deal goes through (Warren Buffett seems to think it will, given his merger arbitrage bet), Microsoft will not only have one of the deepest lineups of video-game brands, but it will be able to offer it to gamers at a deal that will make it hard for rivals to match.
Activision's Call of Duty and Blizzard's Diablo are two epic titles that could draw massive crowds towards Microsoft's Xbox Game Pass service. Undoubtedly, Microsoft's massive scale and deep pockets allow it to offer consumers extraordinary value with its monthly subscription.
Though video games are a wildly-competitive field, Microsoft already has the foundation and library to build a moat around its share of economic profits in the gaming world. Once the metaverse goes live, it will be nearly impossible, even for a big tech rival, to catch up to Microsoft.
Though Microsoft will never have a monopoly in gaming, it has set itself in a position to become a top-two global behemoth in an industry ripe for further consolidation.
For now, Microsoft's gaming division is growing at a high-teens rate. When you factor in Xbox console shortages and the fact that Xbox Cloud Gaming is still just in beta, it seems more apparent that the division is poised for some much higher growth in the years ahead.
Suppose Activision Blizzard is given the green light. In that case, gaming could be in for some Azure-like growth, as consumers stop buying games outright, opting instead to subscribe to Xbox Game Pass.
Wall Street's TakeTurning to Wall Street, MSFT stock comes in as a Strong Buy. Out of 24 analyst ratings, there are 24 Buy recommendations.
The average Microsoft price target is $363.09, implying upside potential of 28.8%. Analyst price targets range from a low of $320.00 per share to a high of $411.00 per share.
The Bottom Line on MicrosoftMicrosoft's Azure really pulled through in the latest quarter, allowing it to beat and raise at a time when its FAANG peers fumbled on guidance, earnings, or both.
With an ambitious gaming foundation, look for the Xbox division to take its growth to the next level. While it may not enjoy Azure-like growth anytime soon, I think that a notable growth acceleration is achievable from the segment as it solidifies its position as the Netflix (NFLX) of games.
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Tech shares have taken a beating in 2022 as higher interest rates decreased the present value of future earnings growth. Investors are thinking twice before paying above-market multiples, and are focusing on value stocks instead.
However a somewhat overlooked fact is that technology companies often have a very conservative capital structure. Most big technology companies, such as Apple (AAPL), are sitting on a net cash position. This is in contrast to utility and real estate companies, which often use leverage to juice up returns.
Avenues to Deploy Excess CapitalThere are several different ways companies can deploy this excess cash. First, they can invest it in their core businesses and grow organically. Second, they can use it for acquisitions. Third, they can return it to shareholders via dividends and buybacks. Lastly, they can keep their options open, and keep the dry powder on their books.
The last option allows companies to exploit periods of market turmoil to boost returns. This is what Warren Buffet does at Berkshire Hathaway (BRK.B). Berkshire ended Q1 2022 with around $103 billion in cash, down from $144 billion at the end of Q4 2021. In essence, Berkshire deemed the opportunities in Q1 2022 worth deploying some 28% of its cash pile.
It is likely that dropping share prices will prompt corporate treasurers to deploy the excess cash reserves accumulated in the good days. Nevertheless, as we have seen at Berkshire, some of the cash will remain on the books.
In this article I will explore what effects rising rates will have on corporate profits for some of the tech companies sitting on the largest cash pile.
AppleAt the end of Q1 2022 -- which for Apple is Q2 given the September financial year -- the interest-sensitive portions of Apple's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$28.1Marketable securities$164.6Commercial Paper$7Term debt$113Total$192.7$120Selected Balance Sheet Items, Author's calculations based on Q1 2022 disclosureIn total, Apple is sitting on a net cash position of about $72.7 billion, which could fetch an extra $2 billion a year in pre-tax profits if reinvested at the 3% Fed funds rate currently expected by the market over the medium term.
The impact from the extra income largely depends on Apple's product cycle. I think the effect will be more noticeable in years without major product releases. Overall though the impact should be a boost to earnings by 2-3%.
Alphabet (GOOGL)At the end of Q1 2022, the interest-sensitive portions of Google's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$20.9Marketable securities$113Long-term debt$14.8Total$133.9$14.8Selected Balance Sheet Items, Author's calculations based on Q1 2022 disclosureOverall, Google has at its disposal some $119.1 billion net for reinvestments, which could boost pre-tax income by some $3.3 billion over the medium term. Given the more conservative balance sheet of Google as compared to Apple, the boost to earnings should be around 4%.
Meta Platforms (FB)At the end of Q1 2022, the interest-sensitive portions of Facebook's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$14.9Marketable securities$29Total$43.9Selected Balance Sheet Items, Author's calculations based on Q1 2022 disclosureCuriously, Facebook has no debts. As the company moves into a more mature phase, this may prompt the corporate treasurer to diversify the capital structure.
This should allow debt investors to have an allocation towards Facebook, and at the same time potentially lower the cost of capital.
As things stand, the net cash position of around $43.9 billion should bring an extra $1.2 billion in pre-tax income over the medium term. The overall boost to pre-tax income should be around 3%.
Amazon (AMZN)At the end of Q1 2022, the interest-sensitive portions of Amazon's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$36.4Marketable securities$30Long-term debt$47.5Total$66.4$47.5Selected Balance Sheet Items, Author's calculations based on Q1 2022 disclosureAmazon recorded a sharp drop in marketable securities in Q1 2022 to $30 billion, down from $59.8 billion in Q4 2021. This was partly the result of a $8.2 billion valuation loss, of which $7.6 billion was due to a writedown in the value of Rivian (RIVN).
As of the end of Q1 2022, Amazon held a circa 18% stake in the electric car maker. Overall, the benefit to pre-tax profit from the reinvestment of the spare cash would be in the 1%-2% range.
Microsoft (MSFT)At the end of Q1 2022 -- which for Microsoft is Q3 given the June financial year -- the interest-sensitive portions of Microsoft's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$12.5Short-term investments$92.2Long-term debt$50Total$104.7$50Selected Balance Sheet Items, Author's calculations based on Q1 2022 disclosureThe reinvestment of the net cash position of Microsoft at circa $54.7 billion would results in a pre-tax earnings boots of close to 2%.
Intel (INTC)At the end of Q1 2022, the interest-sensitive portions of Intel's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$6.2Short-term investments$32.5Debt$37.25Total$38.7$37.25Selected Balance Sheet Items, Author's calculations based on Q1 2022 disclosureDespite boasting a large absolute cash pile, Intel's actual net cash position is negligible when the debt is taken into account.
Tesla (TSLA)At the end of Q1 2022, the interest-sensitive portions of Tesla's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$17.5Short-term investments$0.5Debt and finance leases$4.8Total$18$4.8Selected Balance Sheet Items, Author's calculations based on Q1 2022 disclosureAutomakers have traditionally relied on having a sizable cash pile to ride out industry downturns. Tesla's $13.2-billion net cash position could boost pre-tax profits by $350 million, or 5%-6%, which is quite significant in percentage terms.
In absolute terms, however, given the market capitalization of the company, the effect would be negligible.
Nvidia (NVDA)At the end of January 2022, the interest-sensitive portions of Nvidia's balance sheet were as follows:
Balance sheet item, USD billionAssetsLiabilitiesCash and equivalents$2Short-term investments$19.2Long-term debt$10.9Total$21.2$10.9Selected Balance Sheet Items, Author's calculations based on January 2022 Annual reportNvidia boasts a net cash position of around $10.3 billion. A reinvestment at the expected 3% Fed funds rate could boost pre-tax returns by $275 million, or close to 3%.
SummaryWhen it comes to the cash pile of tech companies, the devil is in the details. Overall, the group will be a net beneficiary of higher rates.
Older tech companies, such as Intel, Microsoft, and Apple, have a more diversified capital structure, and a sizable debt component.
Over the short term, Tesla looks like the biggest winner of higher rates. However, this is the result of a small pre-tax profit relative to the net cash position.
I expect the effect to diminish as car production increases in the future, boosting pre-tax profits. Over the medium term, Google parent Alphabet should be the biggest beneficiary of higher rates, given its meaningful $119.1 billion net cash and cash equivalents position.
All in all, while higher rates will by no means be a main driver for tech earnings, most names should experience an earnings per share bump of several percentage points.
The effect may end up being slightly larger over the very short term. This is due to the fact that the debt companies have issued is usually with a fixed interest rate.
Eventually, these bonds will have to be refinanced at higher rates. In the meantime, however, their immediate cash reserves can be redeployed very quickly at the higher Fed funds rate.
Of course, this is offset by the fact that companies themselves have invested a portion of their marketable securities into longer-duration instruments.
At the end of the day, there is still a silver lining for tech shares when higher rates are concerned.
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