Microsoft holds strong upside for investors, says Morningstar

-- | 05/03/2019

Page 1 of 1

Dan Romanoff: We see wide-moat Microsoft as an attractive investment opportunity throughout 2019, as there are very few companies the size of Microsoft that can offer 12 per cent revenue growth and 15 per cent earnings growth in each of the next several years. With shares hovering around US$ 111, we see more than 15 per cent upside to our US$ 130 fair value estimate.

We expect revenues to be driven by the explosive growth of Azure, and the continued growth of both Office and Dynamics as those businesses shift to a subscription model. Microsoft has passed a trough in top-line momentum due to the shift from a perpetual license model to a subscription model to the point where growth has accelerated and margins are improving.
Office 365 subscriber adds have been robust and will remain so in the near term our view. Dynamics 365 is already a US$ 2.5 billion business, with growth accelerating nicely in fiscal 2018 to 13 per cent, and accelerating further in the December quarter to 20 per cent year over year.
The inclusion of LinkedIn's Recruiter and Sales Navigator solutions into Dynamics further rounds out the suite and is clearly having a positive impact on sales momentum. By mid-year we also expect the chip shortage for low-end PCs to ease, allowing the cash cow Windows operating system business to perform a little better as well.

We estimate Azure is approximately a US$7 billion business and it still grew by a staggering 76 per cent year over year in the December quarter. The battle for cloud supremacy has become a two-horse race between Azure and AWS, and Azure is well-positioned given its installed base at enterprise customers with Server, Database, Dynamics, and Office. Enterprise clients are increasingly adopting a hybrid cloud environment, which plays into Microsoft's strong position, as the company can offer customers their existing environment in either public cloud or on-premise flavours.

The model transition has also passed the pain point for margins, which cratered from 39 per cent in fiscal 2011 to 19 per cent in fiscal 2015, and have already rebounded to 32 per cent last year. While Azure is still below corporate average gross margin, it is scaling rapidly, with commercial cloud gross margin up 500 basis points year over year in the December quarter. We believe there is a long runway for margin improvement as all of the company's cloud businesses continue to scale throughout 2019.

This report appeared on www.morningstar.com.au 2019 Morningstar Australasia Pty Limited

© 2019 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written content of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.