Microsoft's (MSFT 0.39%) business is growing and still generating impressive profits and cash flow. Yet the expansion pace is slowing in areas like digital advertising and the broader PC market. And Microsoft is facing new profit pressures thanks to inflation and currency exchange rate swings. Those were the big-picture takeaways from the company's late July earnings report that covered the selling period through June.
CEO Satya Nadella and his team added valuable context around those headline results in a shareholder report. Let's look at three important slides in that presentation.
1. The big-picture results
Image source: Microsoft investor presentation.
Microsoft's 12% revenue increase for fiscal Q4 looks better once you account for the huge currency exchange rate swings that occurred over the last few months. On a constant currency basis, revenue was up 16% in fiscal Q4, compared to a 21% boost in the prior quarter.
Looking at the major revenue lines shows how the slowdown is mainly coming from areas outside of the core cloud services business. Microsoft's cloud segment grew at a 25% rate while the PC unit only expanded at a 5% pace. Executives said demand worsened for PC products in the wake of pandemic-related social distancing and remote work trends. The non-cloud segments were also hurt by weaker digital advertising spending.
2. What went wrong
Image source: Microsoft investor presentation.
Parts of Microsoft's refreshed outlook constitute a downgrade from the forecast that executives issued back in April. However, that modest reduction mainly came from external and/or temporary challenges.
The strengthening U.S. dollar, for example, erased $600 million from reported revenue this quarter and knocked $0.04 off earnings per share. Microsoft also took new charges related to its pause in operations in Russia.
There was one important negative surprise related to the demand, though. Microsoft said waning excitement in the PC hardware market reduced segment sales by over $300 million. As expected, the video game division was also under pressure compared to soaring results in the past year.
3. What's going well
Image source: Microsoft investor presentation.
Stepping back, Microsoft's business looks impressive, notwithstanding weaknesses in a few parts of the portfolio. Operating profit margin is holding steady at near-record levels of 20% of sales.
Gushing cash flows are allowing for aggressive investments into the most attractive parts of the business, like cloud services, while still supporting cash returns. Microsoft delivered $12.4 billion to shareholders in Q4, up 19% from a year earlier.
Yet the stock's decline so far in 2022 shows that investors are mainly focused on those weaker aspects of Microsoft's business, which had been projected to continue the impressive growth pace that the company notched in earlier phases of the pandemic. It is becoming clear that some trends, like gaming and remote work, are reverting back toward pre-pandemic levels rather than staying elevated.
Still, cloud services are Microsoft's main sales and profit engine, and that division seems to have a bright future ahead for many years. Therefore, investors should try to avoid getting distracted by slowing short-term growth and focus instead on the company's continued market-share wins and stellar financial metrics. These factors will determine whether the stock will deliver market-trouncing returns to shareholders over many years.
