AI Innovations And Decisive Expansions Set To Propel Cloud And Azure Growth

Key Takeaways

• Microsoft's investment in AI and expansion of its cloud infrastructure solidifies its future growth prospects in Azure and related services.
  
• Strategic focus on integrating AI across products and securing AI deployments aims to enhance productivity, user engagement, and attract large enterprise customers.
  
• Azure's growth faces challenges from AI capacity constraints, regional economic variability, high CapEx for cloud and AI, and risks from the Activision acquisition and Generative AI investment.

Catalysts

Develops and supports software, services, devices and solutions worldwide.

• Microsoft’s investment in AI, including partnerships and the integration of AI accelerators and their own silicon, indicates strong positioning for future growth in Azure and related cloud services, expected to enhance revenue and earnings through diversified and innovative AI offerings.
  
• The expansion of Microsoft Cloud, with specific investments in data center footprint across continents, lays a foundation for global scale and reach, potentially increasing revenue through new and existing cloud services.
  
• The significant growth in Azure AI customers and the deployment of new AI models, including GPT-4, points to Microsoft’s strengthening foothold in AI, likely to impact future growth by increasing Azure's consumption revenue.
  
• Microsoft's strategic focus on integrating AI across its suite of products, including Microsoft 365 Copilot and Dynamics 365, indicates a forward-looking approach to enhancing productivity and efficiency for users, promising to boost subscription revenues and user engagement.
  
• The commitment to security and ongoing investments to secure AI deployments, along with a wide-scale adoption of Azure for critical workloads, underpins Microsoft’s competitive advantage in attracting and retaining large enterprise customers, likely impacting long-term revenue growth and operating leverage.

Assumptions

• Analysts are assuming Microsoft's revenue will grow by 14.5% annually over the next 3 years.
• Analysts assume that profit margins will increase from 36.0% today to 36.2% in 3 years time.
• Analysts expect earnings to reach $133.2 billion (and earnings per share of $18.05) by about September 2027, up from $88.1 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 34.1x on those 2027 earnings, up from 33.9x today. This future PE is lower than the current PE for the US Software industry at 34.9x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.67%, as per the Simply Wall St company report.

Risks

• Persistent AI capacity constraints in Azure could hinder the company's ability to meet rising demand, impacting revenue growth in Azure and related services.
  
• Softness observed in a few European regions on non-AI Azure consumption may signal regional economic issues that could affect overall Azure revenue growth.
  
• Elevated levels of CapEx to support cloud and AI demand, particularly in building and leasing data centers, present a risk of increased operating costs without immediate revenue return, potentially impacting net margins.
  
• Execution risks associated with the integration and realization of benefits from the Activision acquisition, which could affect profitability and operating margins if synergy targets are not met.
  
• The shift towards Generative AI and the necessary investments to scale this technology could impact short-term profitability if monetization lags behind CapEx, affecting earnings.

Valuation

• The analysts have a consensus price target of $502.43 for Microsoft based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $600.0, and the most bearish reporting a price target of just $440.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $367.5 billion, earnings will come to $133.2 billion, and it would be trading on a PE ratio of 34.1x, assuming you use a discount rate of 6.7%.
• Given the current share price of $401.7, the analyst's price target of $502.43 is 20.0% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.