Microsoft Surges on AI Tailwinds, Cloud Dominance

Microsoft Corp’s stock has soared over 40% year-to-date, outperforming major indexes, as the tech behemoth continues riding an artificial intelligence wave while maintaining a stranglehold on cloud computing.

Shares of the Redmond, Wash., company have jumped from around $245 at the end of 2022 to over $340 currently, adding nearly $1 trillion in market capitalization. The torrid rally has vaulted Microsoft into the trillion-dollar club, joining peers like Apple Inc., Alphabet Inc. and Amazon.com Inc.

Fueling the run has been enthusiasm for Microsoft's AI endeavors, particularly its new Bing search engine powered by advanced language models. The company has also leaned into AI for its Office productivity suite, Windows operating system and cloud services.

"AI has rejuvenated parts of Microsoft's business and reenergized the growth story," said Dan Ives, analyst at Wedbush Securities. "This is just the ground floor of what transformational AI means for Redmond over the coming years."

At the core driving Microsoft's ascent has been continued torrid growth in its cloud computing segment. Azure, the company's flagship cloud platform, saw revenue surge 27% in the latest quarter. It remains locked in a fierce battle for cloud supremacy with Amazon Web Services but has consistently gained share.

The cloud business, which includes server products, enterprise services, and Azure, accounted for 51% of total revenue in the most recent quarter. It's been one of the company's fastest growing units, with commercial cloud revenue hitting $31.4 billion for the nine-month period ended March 31, up 27%.

Dan Morgan, senior portfolio manager at Synovus Trust, has been impressed by Microsoft's ability to cross-sell its cloud services. He sees more runway ahead as hybrid work trends accelerate cloud adoption.

"They've done an excellent job transitioning from an on-premise software model to a cloud/subscription business," said Morgan. "We see Microsoft continuing to take share in areas like productivity applications, security and compliance in the cloud."

Microsoft has increasingly bundled its myriad cloud offerings for enterprises in packages like Microsoft Cloud for Sovereign Cloud and Microsoft Cloud for Sustainability. Morgan sees further opportunity to cross-pollinate AI models like ChatGPT into productivity suites, gaming, security and more verticals.

Beyond cloud, growth drivers for the tech titan include:

•Windows Operating System - Windows 11 and the ability to monetize the massive installed base through upgradesubscription cycles

•Gaming - The Xbox platform and pipeline of major game releases, plus cloud gaming service

•Security Software - Doubling down on security solutions amid rising cyber threats

While challenges remain, like sustaining Azure's red-hot pace and fending off rivals, Microsoft appears well-positioned with its Azure/Office/Windows franchises to capitalize on sectular cloud/AI trends.

Brad Reback, analyst at Stifel, believes this sets up Microsoft as a core AI/cloud play for years. He raised his price target to $380 last month.

"We see a budding 'renaissance' at Microsoft re-accelerating revenue/EPS growth as the company doubles down on leading incentives in key disruptive themes in AI, cloud computing, cyber security and new computing form factors," said Reback.

Another positive has been Microsoft's consistent shareholder returns through dividends and repurchases. The company recently hiked its quarterly cash dividend by 9.6% to $0.68 per share. It's also bought back nearly $10 billion in stock over the past year.

Key Metrics Shine

While execution and vision has powered Microsoft, the financials reflect a well-oiled machine firing on all cylinders:

•Revenue grew 18% in the March quarter to $52.9 billion, beating estimates

•Intelligent Cloud revenue jumped 16% to $22.1 billion

•Operating margins expanded to 41.6%

•Earnings per share of $2.39 topped projections

•Total remaining performance obligations (RPO) hit $195 billion, up 24%

•Commercial RPO increased 28% to $226 billion

The combination of durable double-digit revenue growth, expanding margins, and skyrocketing backlog/RPO have Microsoft printing cash. Operating cash flow hit $24.1 billion in the latest quarter.

RBC analyst Rishi Jaluria believes Microsoft's cloud momentum remains underappreciated. He raised estimates recently, citing Azure's reacceleration and growing pipeline. His bull case $420 price target implies another 25%+ upside from current levels.

"We continue to view Microsoft as a core cloud holding, with Azure persisting as a share gainer in the cloud transition," said Jaluria. "We think the stock has material upside given the inflection in Azure growth, margin expansion potential, and capital return story."

Brent Thill, analyst at Jefferies, upgraded Microsoft shares to Buy in May with a new $400 price target. He's bullish on the company's positioning within generative AI workflows and products.

"Microsoft is at the forefront catalyzing the AI revolution, leveraging its Office, Azure, security and gaming footprints to commercialize these next-gen models," wrote Thill. "We see Microsoft as a key disruptive force and franchise beneficiary in this transition."

Risks Remain

Even with AI and cloud tailwinds, there are risks that could derail Microsoft's impressive run. Competitors like Google, Amazon, Nvidia and others are heavily investing in AI and cloud capabilities.

Regulatory headwinds pose threats around data privacy, antitrust and other areas. Microsoft was recently forced to make concessions over its $69 billion acquisition of gaming giant Activision Blizzard amid regulatory scrutiny.

Changes to corporate IT spending as inflation persists and economic growth sputters could impact cloud, enterprise and productivity revenue streams. Employee attrition and talent wars are also concerns amid the aggressive push into AI.

But Ives at Wedbush believes the risk-reward is firmly skewed to the upside. His bull case $400 price target is predicated on Microsoft successfully monetizing AI across its product stack over the coming years.

"While not without risks, we ultimately believe Microsoft is positioned to be one of the biggest disruptors and beneficiaries of the AI revolution over the next decade," said Ives.

The coming quarters and years will reveal whether the AI/cloud growth drivers can propel Microsoft to new market cap milestones or if competition, regulation and macro conditions restrain its unfettered ascent. For now, the stock's 2023 resurgence reflects investors' confidence in its tech dominance and ability to ride transformational trends.

That's precisely the type of performance CEO Satya Nadella envisioned when he set the company on a cloud/AI course nearly a decade ago.