Microsoft could be the cloud sector's 'canary in the coal mine,' even as AI efforts offer promise

10:17 am ET January 25, 2023 (MarketWatch) Print

By Barbara Kollmeyer and Emily Bary

Earnings reveal problems that are 'more macro than Microsoft'

Microsoft Corp. has big opportunities ahead in artificial intelligence, but first the company must contend with a slowdown in the cloud computing business that threatens to envelop the broader software industry.

While Microsoft (MSFT) executives were upbeat Tuesday about their ability to capitalize on AI, including through a new investment in the popular creator of ChatGPT, Wall Street couldn't ignore the more immediate-term forecast that accompanied Microsoft's latest earnings report.

Opinion: Microsoft's big move in AI does not mean it will challenge Google in search

Shares of the technology giant were down 3.5% in morning trading Wednesday following the company's March-quarter revenue forecast, which came in below analyst expectations, as well as Chief Financial Officer Amy Hood's commentary that the customer "caution" witnessed in the December quarter was expected to carry forward.

Shares of fellow cloud-computing players Amazon.com Inc. (AMZN) and Google parent Alphabet Inc. (GOOGL) were also under pressure.

Microsoft's Azure cloud business has been decelerating, and the company's latest commentary has at least one analyst feeling more pessimistic about the growth trajectory. Keith Bachman of BMO Capital Markets said he previously thought Azure growth would "flatten out" in the June or September quarters, but now he worries that it could continue slowing through the calendar year.

"In our opinion, Azure likely over-earned for eight quarters from theSeptember quarter of 2020 to the June quarter of 2022 post COVID, so the headwinds to growth likely will last longer than our previous views," Bachman wrote. "We are not comfortable recommending the stock until we have more confidence in the glide path of Azure."

He downgraded Microsoft shares to market perform from outperform following the report, writing that the stock could be held in check until Azure growth stabilizes.

Michael Turrin of Wells Fargo kept his overweight view on the stock, but he also cautioned that it could stay "range bound" until investors see some stabilization in the numbers.

"Perhaps most notable from the call, MSFT's prior guides for 20% [commercial revenue] growth [in constant currency] and double-digit rev/op income growth (in cc) were not reiterated, a clear shift in tone and suggestive of increased uncertainty for the commercial segment," he wrote.

Bernstein analyst Mark Moerdler highlighted that Microsoft's issues seem to be part of a bigger story of industry caution and aren't simply problems of its own making, but that's not to say the company won't see "mixed results."

"The quick answer is we believe that where Microsoft goes so does the rest of Cloud," wrote Moerdler, who rates the stock at outperform. "We are taking down our Microsoft numbers and especially Azure estimates, and we are lowering Microsoft's multiple. However, what we saw in the quarter was more macro than Microsoft and more near-term rather than a longer-term fundamental issue."

He titled his note to clients: "Do we have a problem at Microsoft or is Microsoft the canary in the coal mine for Cloud?"

JPMorgan analysts floated similar industry concerns, though they kept an overweight rating on Microsoft's stock.

"While we do not expect that Microsoft's slowing growth trajectory will be 'the straw that breaks the camel's back,' as its core annuity streams still show relative resilience, we continue to think software sector earnings results and guidance will show signs of strain," said a team led by Mark Murphy.

JPMorgan also lauded Microsoft's AI initiatives, saying while "clearly still early-stage, we believe a paradigm shift is under way and that its OpenAI/ChatGPT could end up being some of the best money ever spent."

Read:Microsoft stock dives into the red after forecast misses, CFO warns about deceleration

As for those looking past the cloud, Gil Luria, senior software analyst at D.A. Davidson, said that estimates for Microsoft are now "derisked," something that can't be said yet for Big Tech peers Amazon, Apple Inc. (AAPL), and Alphabet which haven't yet reported for the quarter.

Luria touched on the company's "multibillion-dollar" investment in ChatGPT-maker OpenAI announced Monday.

With factors like the Azure slowdown now "better understood," he said that "attention should increasingly shift to the positive impact of generative AI and the significant benefit from the OpenAI investment."

Chief Executive Satya Nadella "reviewed the broad implications across the portfolio, but we believe the short-term benefits to Azure (as much as $0.50 by 2025) and Bing (a jump ball in the $160B market) will become more evident over the next few months," Luria wrote.

Opinion:Microsoft gave Wall Street hope, but then the cloud forecast turned dark

A team of analysts Citigroup led by Tyler Radke said Microsoft's "conservative" guidance, notably for Azure, was indeed a sign it was looking to "derisk" for a tougher 2023. And even on lower numbers, consolidated revenue and earnings per share growth are "beginning to accelerate from these levels, which we think can be a differentiator," said the analysts.

"We continue to see MSFT among best positioned large-cap software names given consolidation potential across key markets in security/AI and good balance of growth/profitability," added Citi.

-Barbara Kollmeyer

(END) Dow Jones Newswires

January 25, 2023 10:17 ET (15:17 GMT)