Why the Street Skipped a Beat on This Company’s Earnings
Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If you ever need evidence that Wall Street can carry a grudge, Microsoft’s (NASDAQ: MSFT) second quarter earnings report serves as a perfect example. Although I’ve been hard on the company recently, I’m nonetheless prepared to give credit where credit is due.
Granted, Microsoft’s management team has frustrated analysts for quite some time. However, on the heels of Apple’s (NASDAQ: AAPL) disappointing results, one would think that Microsoft would get the benefit of the doubt after an earnings beat. Wall Street saw things differently.
The Quarter That Was
After coming off a putrid first quarter, during which the software giant missed on both the top and bottom lines, Microsoft had a lot to prove. That the company saw an 8% decline in revenue coupled with shedding 22% in EPS speaks to the degree with which PCs were dying – it was no longer a myth.
Consequently, analysts began to drop estimates ahead of the report. The Street was calling for 75 cents per share on revenue of $21.7 billion, representing a profit decline of 5% with a modest 4% sales growth. In other words, Microsoft needed to convince a pessimism-filled market that it can shed its PC dependency. In many respects, Thursday's announcement made a great case.
For the quarter, Microsoft beat Street EPS estimates by a penny – posting 76 cents per share on revenue of $21.46 billion. That revenue arrived 3% higher year-over-year was unimpressive. Likewise, profitability was weak, sagging almost 4% year-over year.
Plus, this highlighted the sluggish nature that has aggravated investors for a decade. Then again, that sales grew 34% sequentially was a welcomed surprise. But as noted above, revenues declined 8% in Q1. So, that it grew 34% in Q2 may or may not matter a whole lot.
Clearer Windows and Surface Cleaned
The good news though, is that the Windows division picked up the slack, growing impressively by 24%, which led to a 14.4% increase in operating income. The primary driver was Windows 8, which was launched in October and has come under fire due to disappointing initial sales results. But the quarter told a different story.
Microsoft said it sold 60 million licenses of its newest operating system, which helped advance Windows division revenue to $5.9 billion – reversing the dismal Q1 performance during which Windows revenue declined 33%.
What’s more, it was encouraging that the Windows uptick was attributed to stronger than expected Surface sales -- especially since the tablet has had a hard time competing with Apple’s iPad. However, that Apple’s margins continue to come under pressure is reflective of the traction that Microsoft (among others) has gained – not just in tablets but also in phones.
For instance, even though Apple recently beat EPS estimates of $13.34 by posting $13.81 per share, the major focus was on revenues – in particular, that it missed estimates on iPhone sales. Buy side analysts were looking for 50 million, Apple posted 47.8 million. It was not a terrible number, but it just wasn’t enough. Obviously, Microsoft’s growth had a hand in that.
While I don’t doubt for a second that Apple is still the leader, the gap is nonetheless closing. And this was evident in Apple's numbers. For that matter, Apple appreciates this, which is one of the reasons it decided to adjust how it issues guidance.
Essentially, the tides are beginning to turn – possibly for both companies. But it’s going to get more interesting. In February, Microsoft plans to launch the second version of the Surface tablet, Surface Windows 8 Pro. It remains to be seen if Microsoft can build on this momentum and escape this tunnel. But the company deserves credit for at least having sparked a light.
Enterprise Still a Challenge
While Microsoft did well fixing its Windows and electronics division, the company is still struggling to shore up the enterprise business. Although Server & Tools revenue performed well -- growing 9% to $5.19 billion -- Microsoft lost 10% in the Business Division, which includes Office.
Likewise, although revenue for the Online Services division grew 11%, it still registered a loss of $283 million. While it’s a 40% year-over-year improvement, on aggregate, the online business division, which competes with cloud rivals Oracle (NASDAQ: ORCL) and Salesforce.com (NYSE: CRM), has lost $647 million on the year.
Granted, Microsoft is making improvements in key areas. But its enterprise and cloud strategies remain a concern – especially since it presents higher profit margins. Meanwhile, this has not escaped Oracle, which seems more nimble and better prepared.
The database giant has been spending its cash on acquisitions such as RightNow and Taleo to help grow its cloud and enterprise offerings. Too, Oracle’s ability to post 17% growth in its software and subscription business means that the company is already stealing share from Microsoft in that market.
Then there’s Salesforce.com, which has a comfortable lead in the software as a service (SaaS) market. Although Microsoft has begun to plant its flag with Azure, the environment will prove insurmountable for Microsoft to mount any type of rebound – especially since it is being outmaneuvered by both Oracle and Saleforce.com
Salesforce.com has spent close to $1 billion buying up niche cloud/social media names such as BuddyMedia to make certain that its lead remains intact. And Salesforce.com’s recent quarter during which revenue grew 35% proved that it’s making all the right moves.
The performance was helped by better than expected showing in the company’s services support and subscription business, which grew 35% year-over-year. Essentially, Saleforce.com’s recent use of cash has worked. Meanwhile, Microsoft’s management has instead opted to raise its dividend. There’s a clear difference in philosophy.
Despite the clear improvements in this recent quarter, Microsoft has not gotten the credit it deserves. One major reason is the Street’s contempt for the company’s management team. Fairly or unfairly, that’s the way it is. But the stock is interesting though.
While I see value in the shares at current levels, I’m not compelled to buy – not with revenues growing at an uninspiring 3%. However, the dividend changes the picture and Microsoft offers one of the best yields on the market. Plus, the stock has plenty support -- the fundamentals are too strong for a collapse. That said, $30 per share is a reasonable target by the second half of the year.
rsaintvilus is long Apple and has no position in any other stocks mentioned. The Motley Fool recommends Apple and Salesforce.com. The Motley Fool owns shares of Apple, Microsoft, and Oracle. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!