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Microsoft
is expected to beat Wall Street earnings estimates when it releases fourth-quarter financial results next Thursday, Citigroup analyst Walter Prichard says in a Friday research note. But he has longer-term concerns about the upside potential of Microsoft, which is trading near an all-time high with a market capitalization of $1.06 trillion, higher than any other company on earth.
Citi analyst forecasts revenue for the quarter of $33.2 billion, ahead of Street consensus at $32.7 billion, with earnings of $1.24 a share, pennies on Street at 1 $.21 and what Pritchard says is Microsoft’s implied advice (ticker: MSFT) of $1.18 to $1.21 per share. (The company isn’t explicit about earnings forecasts, but does provide some substantial hints.)
Pritchard sees particularly strong bookings in the quarter for the company’s Azure cloud services, and its gross margin forecast, at 65.8%, is just a few ticks above consensus at 65.4%. The same trend is true for operating margins (it is at 34.6%, against the street at 34.0%) on a more favorable business mix.
Pritchard notes that it’s also above the first-quarter earnings consensus, forecasting earnings of $1.22 a share, ahead of the street at $1.18.
The Citi analyst raised his price target on the stock to $147 from $130 on Friday, but he maintains a neutral rating. “We expect a strong quarter to come as no surprise given recent strong stock action and the focus will likely be on management’s comments regarding the perception of macro risks heading into the fiscal year. 2020,” he wrote. “Other considerations include the impact on the PC market of trade wars and the dividend policy to be adjusted in September, after a relatively tepid increase a year ago.”
Longer term, Pritchard sees two major problems for Microsoft stocks.
First, he has questions about the future of Windows and the company’s involvement in mainstream business more generally.
“We are of the view that Microsoft really has no choice but to exit the consumer markets and Windows is the platform that allows MSFT to enter the consumer market (and therefore possible monetizations in its business very profitable business),” he wrote. . “We conclude that it is unlikely that MSFT could exit any of its consumer businesses without harming the prospects of the rest of its businesses (especially with convergence between platforms/devices/work and personal experiences), and so it must continue to invest heavily in these low-margin, highly competitive markets.
Second, Pritchard questions the profitability of the company’s enterprise operations as the cloud transition continues. “With commercial licenses accounting for approximately 60% of MSFT’s gross profits, MSFT’s shift to cloud-based solutions has significant implications for the company’s overall profitability,” he writes.
Pritchard sees two wrinkles in this transition: the move to subscription from upfront payments and the move to low-margin cloud services. “We believe that while there will most likely be an eventual increase in revenue (more than 3 years), the business will not return to its former level of profitability and the consensus does not fully reflect this reality,” he wrote.
Microsoft stock is up 43 cents, or 0.3%, today at $138.83, just slightly below its all-time high of $139.22. Shares are up 36.7% in 2019.
Write to Eric J. Savitz at eric.savitz@barrons.com
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