We’re upgrading Microsoft after earnings. The stock has pulled back enough lately

Microsoft delivered an overall strong quarter after Tuesday’s market close, but a miss on Azure revenue growth put shares under pressure in extended-hours trading. Revenue increased about 15% year over year to $64.73 billion in its fiscal 2024 fourth quarter, beating the Street consensus estimate of $64.39 billion, according to data from LSEG. Earnings per share increased nearly 10% from last year to $2.95, ahead of EPS estimates of $2.93, 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. 21, 2023 Initiated : Dec. 4, 2017 Bottom line We were so close to having an encore of the picture-perfect results we got in Microsoft’s fiscal third quarter. In addition to fiscal Q4 sales and earnings outpacing expectations, gross, operating, and net profit margins were all better than expected at the companywide level. Operating profitability was stronger than expected in all three main operating segments. Cash flow generation was also much more than expected despite slightly higher-than-expected operating expenses and capital expenditures to support the company’s cloud and artificial intelligence offerings. The one major miss was at Azure, which is the one unit investors are hyper-focused on. That sent the stock lower by more than 2.5% following the release. If anything, with shares ahead of the print down nearly 10% from their all-time highs set earlier this month, the reaction to Microsoft’s results may serve as a clearing event that can help the stock bottom out before rebounding into the end of the year. We’re therefore reiterating our $500 per share target and upgrading shares back to our buy-equivalent 1 rating . MSFT YTD mountain Microsoft YTD Azure was light — there’s no sugarcoating it — but we don’t think it’s a sign that the AI trade is over. On the post-earnings call, CEO Satya Nadella said, “The number of people who use [Copilot for Microsoft 365] daily at work nearly doubled quarter-over-quarter as they use it to complete tasks faster, hold more effective meetings, and automate business workflows and processes.” Copilot customers increased more than 60% quarter-over-quarter. Nadella added, “Feedback has been positive with majority of enterprise customers coming back to purchase more seats. All up, the number of customers with more than 10,000 seats more than doubled quarter-over-quarter.” While some may fret over the current level of spending in hopes of future financial gains, we think it’s important for investors to zoom out. CFO Amy Hood said on the call, “Cloud and AI-related spend represents nearly all of our total capital expenditures. Within that, roughly half is for infrastructure needs where we continue to build and lease data centers that will support monetization over the next 15 years and beyond. The remaining cloud and AI-related spend is primarily for servers, both CPU and GPUs to serve customers based On Demand signals.” Those are positive demand signals for those serving up data center chips, such as Club names Nvidia , Broadcom , and Advanced Micro Devices . AMD reported strong results Tuesday evening, validating our decision to reinvest in the stock. Forward guidance for the current quarter, fiscal 2025 Q1, was short, but the stock managed to pare some of its losses after management provided a positive outlook regarding the cadence of Azure growth. The team expects to see an acceleration in the second half of fiscal 2025. Investors had been expecting to see a bit of a slowdown over that stretch. That’s still months away. It may as well be an eternity as we’re only a month into the new fiscal year. But along with strong customer adoption, we think the commentary about the future supports our view that generative AI and the offerings coming from Microsoft are very real and being leveraged by companies across industries to the benefit of both sales and cost efficiencies. Quarterly results Aside from the Azure miss, the quarterly results were quite strong. The Productivity and Business Processes segment grew revenue by 11% to $20.32 billion, exceeding expectations of $20.14 billion. Operating income in the segment also outpaced expectations. Office Commercial Products and Cloud Services revenue rose 12% year-over-year, with Office 365 Commercial seats increasing 7% versus the year-ago period driven by small and medium business and frontline worker offerings, as well as growth in revenue per user. Office Consumer Products and Cloud Services revenue grew 3% as Microsoft 365 Consumer subscriptions grew 10% to 82.5 million. LinkedIn revenue grew 10% with strength seen in all lines of business. Dynamics Products and Cloud Services revenue was up 16% year-over-year, driven by 19% growth in Dynamics 365. Intelligent Cloud revenue came up short at $28.52 billion, versus expectations of $28.7 billion. While Azure grew slower than expected, it was still up 29% year-over-year — 30% on a constant currency basis — helping drive nearly 19% revenue growth in the segment versus the year-ago period. Under that decision, Server Products and Cloud Services revenue was up 21% year-over-year. Azure and Other Cloud Services sales were up 29%, with 8 percentage points attributable to AI services. The Street, however, was looking for a year-over-year growth rate 1 percentage point faster than what the company reported, which is why we’re seeing shares pullback further after hours. Server Products and Cloud Services revenue was up 21% year-over-year. Azure and Other Cloud Services sales were up 29%, with 8 percentage points attributable to AI services. The Street, however, was looking for a year-over-year growth rate 1 percentage point faster than what the company reported, which is why we’re seeing shares pullback further after hours. Server Products sales increased 2% year-over-year. The Enterprise Mobility installed based increased 10% to 281 million seats. Revenue in the More Personal Computing segment grew 14% year-over-year to $15.9 billion, though it should be noted that 12 percentage points of that growth are attributable to the Activision acquisition. Windows OEM revenue increased by 4%, the fourth straight quarter of growth as personal computer market volumes held at pre-Covid pandemic levels. Windows Commercial Products and Cloud Services revenue increased 11%, driven by demand for Microsoft 365. Search and News Advertising — excluding traffic acquisition costs — were up 19%, a significant acceleration from the 12% increase in fiscal Q4 “driven by higher search volume and higher revenue per search,” the company said. Devices revenue fell 11% as management looks to focus on higher-margin premium products. Looking ahead, Nadella said on the call that the company was “delighted by early reviews” of the new Copilot + PCs that were introduced this quarter. In gaming, Xbox Content and Services revenue surged 61% versus the year-ago period. However, Xbox Hardware revenue was down 42% versus the year before. Guidance For its full-year fiscal 2025, Microsoft expects double-digit revenue growth and operating income growth, with operating margins down by about 1 percentage point year over. Assuming stable rates, foreign exchange is not expected to have a material impact on revenue, cost of goods sold (COGS), or operating expense growth. The team expects full-year fiscal 2025 capital expenditures to be higher than the previous year. However, Hood was quick to add on the call that “these expenditures are dependent on demand signals and adoption of our services that will be managed through the year. As scaling these investments drives growth in COGS, we will remain disciplined on operating expense management.” Management expects to keep operating expense growth in the single-digit range. Management’s revenue outlook for its fiscal 2025 first quarter was mixed with the team guiding for revenue to be in the range of $63.8 billion and $64.8 billion. That was below expectations, even on the high end. By segment, Intelligent Cloud, was the only one guided to come in ahead of expectations in fiscal Q1. That’s not great — but if it was only going to be one segment, it’s good that it’s this one given the thorn it was in the side of the fiscal Q4 report. Despite the solid fiscal Q1 outlook for Intelligent Cloud revenue, management guided Azure’s constant currency revenue growth to 28% to 29%. That’s below the 30% the Street was looking for. The team did add that they expect Azure growth to accelerate in the second half of 2025 as “capital investments create an increase in available AI capacity to serve more of the growing demand.” That’s especially notable given the Street had been modeling a slowdown from the fiscal 2025 first quarter into the second, no change sequentially from fiscal Q2 to the third, and another deceleration from fiscal Q3 into the fourth. So, the idea of an acceleration in Azure revenue in the back half of the new fiscal year is especially welcome given the miss we received for both the reported quarter and the current one. (Jim Cramer’s Charitable Trust is long MSFT, NVDA, AVGO, AMD, AMZN, GOOGL. 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. 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