We see shares as fairly valued today, but prospective investors should keep an eye on Microsoft in case of a pullback.
By Rodney Nelson | 10-20-16 | 06:00 PM | Email Article

 Microsoft  opened its fiscal 2017 with a strong first quarter, as the company again realized torrid growth rates across its core cloud products, including another quarter of triple-digit revenue and usage growth from Azure. Further, we saw positive momentum in cloud gross margin, which rose 700 basis points to 49% in the quarter. We continue to be encouraged by management’s adept handling of Microsoft’s business model transition, providing further support for our wide moat and stable moat trend ratings. We are raising our fair value estimate by $1, to $63 per share, and though shares have rallied roughly 25% over the last four months, prospective investors should keep an eye on Microsoft during pullbacks.

Rodney Nelson is a senior equity analyst for Morningstar.

First-quarter non-GAAP revenue (which includes Windows 10 deferrals) rose 3% year over year to $22.3 billion (ahead of our expectations), driven by 8% growth in the firm’s Intelligent Cloud segment. While Azure continues to be the poster child for this bucket (constant currency sales growth of 121%), Office 365 remains an impressive performer, as total Office 365 Commercial revenue rose 54% in constant currency versus the prior year despite just 40% growth in commercial seats, suggesting Microsoft is seeing strengthening ASPs with the product. Consumer Office 365 adoption remains strong as well, as the company added 900,000 subscribers in the quarter. Most encouragingly, the company is seeing an increasing mix of premium services in its Azure business, one of the core drivers of profitability improvements. Management called out increasing use cases around the "Internet of Things" and artificial intelligence as key drivers of both revenue and heightened profitability in the quarter. Investors should be mindful that increasing cloud mix will still weigh on consolidated profitability in the near term, evidenced by the 180- and 90-basis-point year-over-year declines in gross and operating margins, respectively. 

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