Microsoft beat the top-line and bottom-line consensus estimates. However, the revenue guidance fell short of estimates. The company’s December quarter revenue grew by 12.3% YoY to $69.6 billion, beating estimates by 1.2%. The EPS grew by 10.2% YoY to $3.23, beating estimates by 3.9%, driven by strong operating efficiencies.
The company guided the March quarter revenue in the range of $67.7 billion to $68.7 billion, representing YoY growth of 10.3% at the midpoint. However, they were short of analyst estimates of $68.8 billion. The strong US dollar is expected to negatively impact the revenue growth by two percentage points.
Azure grew by 31% and came in at the lower-end guidance range of 31% to 32%. The company’s AI revenue met the management’s expectations. However, the non-AI revenue was slightly lower than expected due to the company’s challenges in the go-to-market execution.
Management provided a soft guide for the next quarter between 31% and 32% in constant currency. Demand for AI products exceeds Microsoft's current capacity, as the company faces challenges building enough data centers to support the high demand. Management expects supply constraints to be resolved by the end of the first half 2025.
Financials
Revenue
The company’s FQ2 (December quarter) revenue grew by 12.3% YoY to $69.6 billion, beating estimates by 1.2%, driven by strong AI and cloud demand.
Microsoft's revenue guidance for the March quarter is $67.7 billion to $68.7 billion, representing 10.3% year-over-year growth at the midpoint. This fell short of analyst estimates of $68.8 billion. A strong US dollar is projected to impact revenue growth by 2 percentage points negatively.
Segments
The company’s Productivity and Business Processes segment, which includes Microsoft 365 subscriptions and LinkedIn, grew by 14% YoY and 13% in constant currency to $29.4 billion, driven by strong Microsoft 365 Commercial offerings. Management expects revenue to grow between 11% and 12% in constant currency or $29.4 billion to $29.7 billion in the next quarter.
The Intelligent Cloud segment, which includes Azure AI revenue, grew by 19% YoY to $25.5 billion. The revenue was below management expectations due to lower non-AI revenue due to the company’s challenges in the go-to-market execution, specifically with customers reached through partner and indirect sales channels as the company balances its resources driving strong AI revenue. The lower non-AI revenue was offset by better-than-expected Azure AI revenue.
Azure revenue grew by 31% and included 13 percentage points contribution from AI services. Management provided a soft guide for the next quarter between 31% and 32% in constant currency. The company is facing challenges in building enough data centers to support the high demand. Management expects supply constraints to be resolved by the end of the first half of 2025, helped by the investments it has made in long-lived assets.
Management expects Intelligent Cloud revenue to grow between 19% and 20% in constant currency or $25.9 billion to $26.2 billion in the next quarter.
More Personal Computing revenue was flat at $14.7 billion. Management expects revenue in the next quarter in the range of $12.4 billion to $12.8 billion as it continues to prioritize higher margin opportunities in this segment.
Margins
The company’s margins have improved this quarter despite AI investments, which are driven by operational efficiencies.
- FQ2 gross margin was 68.7% compared to 68.4% in the same period last year. It was better than the guide of 67.9% due the to focus on higher margin business and partially offset by increased AI investments. Management guide for the next quarter is 68.1%.
- FQ2 operating margin was 45.5% compared to 43.6% in the same period last year. It was better than the guide of 44%, driven by operational efficiencies. Management guide for the next quarter is 44%.
- Net margin of 34.6% was better than the guide of 33.8% compared to 35.3% in the same period last year. Management guide for the next quarter is 34.9%.
EPS
The EPS grew by 10.2% YoY to $3.23, beating estimates by 3.9%, driven by strong operating efficiencies.
Cash Flow and Balance Sheet
- FQ2 operating cash flow grew by 18% YoY to $22.3 billion, driven by strong cloud billings and collections, partially offset by higher supplier, employee, and tax payments.
- Free cash flow was down (-29%) YoY to $6.5 billion due to higher capital investments to support the strong AI demand.
- Cash and short-term investments were $71.55 billion and debt of $44.97 billion compared to $78.4 billion and $45.1 billion at the end of FQ1.
- The company paid $6.2 billion in dividends and repurchased shares worth $3.5 billion in FQ2.
Key Metrics
The company’s commercial RPO grew by 34% YoY and 36% in constant currency to $298 billion. Commitments from OpenAI drove the strong acceleration from 22% growth in FQ1 and also from existing and new Azure customers.
Microsoft Cloud revenue grew by 21% YoY to a record $40.9 billion. The AI business surpassed the annual revenue run rate of $13 billion, up 175% YoY. Cloud gross margin was 70% and in line with the guidance. Management guide for FQ3 is 69%, down from 72% in the same period last year due to higher AI investments.
Risks to consider
The company’s Azure growth in the coming quarters is to be watched. Management provided a soft guide for the next quarter between 31% and 32% in constant currency. Demand for AI products exceeds Microsoft's current capacity, as the company faces challenges building enough data centers to support the high demand. Management expects supply constraints to be resolved by the end of the first half 2025.
Morgan Stanley analyst Keith Weiss asked about the lower Azure growth during the earnings call. The CFO, Amy Hood, provided more context and clarified that the slowdown was due to the challenges in the non-AI Azure revenue. Microsoft's Azure AI revenue in FQ2 exceeded expectations due to operational teams pulling in delivery dates. However, non-AI Azure Compute Revenue (ACR) faced challenges in sales through partners and indirect methods. The company shifted its sales and marketing budgets and resources over the summer to balance AI workloads with ongoing migrations and other customer needs. However, adjustments are still being made to optimize resource allocation. Some impact on non-AI ACR is expected through the first half of 2025 as these adjustments take effect. However, management has not provided a definite timeline for when the non-AI revenue will recover.
The company’s capex is another area to watch in the coming quarters. The rising capex will put pressure on the margins and the cash flows. Capex, including assets acquired under finance leases, was $22.6 billion, up 97% YoY. Cash paid for property and equipment was $15.8 billion. Management expects the spending to be similar to FQ2 spending in the next two quarters. For FY2026, which ends in June, management expects to continue to invest. However, the growth rate will be lower than the FY2025, which is positive news, and the mix will shift back to short-lived assets that are more correlated to revenue growth. The company recently announced plans to invest approximately $80 billion in AI-enabled data centers in FY2025, up 44% YoY.
Valuation
The company is trading at a P/E ratio of 34.3 and a forward P/E ratio of 32, higher than the 5-year average P/E ratio of 33.1. It is trading at a P/S ratio of 12.2 and a forward P/S ratio of 11.1.
Analysts Notes
Morgan Stanley analyst Keith Weiss lowered the firm's price target on Microsoft to $530 from $540 and keeps an Overweight rating on the shares. Commercial bookings growth of 75% year-over-year in constant currency accelerated well beyond expectations, though Azure growth of 31% in constant currency in Q2 came in 1% point below expectations, the analyst tells investors. While Azure was disappointing, strength in the GenAI ramp and moderating capex growth should support accelerating FY26 free cash flow growth, the analyst added.
UBS lowered the firm's price target on the company to $510 from $525 and keeps a Buy rating on the shares. Microsoft's quarter was weaker than expected, with the company pulling its guidance for a second half Azure acceleration, citing sales execution, the analyst tells investors in a research note. While the improvement in the fiscal 2025 margin guidance as well as the guide for capex growth to moderate in fiscal 2026 will help, three straight quarters of an Azure disappointment with a different explanation each time undermines confidence in the growth outlook, the firm argues.
Mizuho lowered the firm's price target on Microsoft to $500 from $510 and keeps an Outperform rating on the shares. The company reported a decent fiscal Q2 but Azure revenue growth of 31% year-over-year was at the low end of management' guided range as Microsoft' non-artificial intelligence go-to-market execution was subpar, the analyst tells investors in a research note. Meanwhile, the company's Q3 revenue guidance was below Street expectations due to a $1B currency headwind, adds Mizuho. Despite the disappointment, the firm remains confident that Microsoft's revenue growth opportunities over the medium-term and beyond are greater than many realize.
Conclusion
Microsoft beat the top-line and bottom-line consensus estimates. However, the revenue guidance fell short of estimates. The margins have improved this quarter and the company has controlled costs well despite increasing AI investments. The key hurdle for the company in the coming quarters is to resolve the supply constraints and the challenges in the go-to-market execution.
Over the coming months to year, we are looking for an entry into Microsoft as we ultimately foresee Azure accelerating from AI. For now, the market is discounting the stock on the high capex spend and relatively low ROI from AI, perhaps affording a lower entry for this cloud and AI juggernaut
Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
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