Microsoft could be poised to post returns in the mid-teens this year, according to one firm. Morgan Stanley analysts upgraded the software giant’s stock from Equal-weight to Overweight and raised their price target from $57 to $66 per share, crediting improving confidence and sustainable earnings growth for their more optimistic view.
Their upgrade comes less than a month after Goldman Sachs upgraded the stock.
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Is Microsoft turning the corner?
Analyst Keith Weiss and team noted that Microsoft has been struggling for about the last five years. The consumer PC business, once its bread and butter, has been declining as consumers prefer other devices over PCs. The company also missed out on the mobile opportunities and still is struggling in this area. At the same time, Microsoft has been working on transitioning itself into a cloud-based business, and in terms of macro issues, currency headwinds have weighed on all tech companies.
All of these factors have worked together to keep earnings per share growth stagnant, said Weiss and team in their report dated Jan. 13.
Why 2016 looks better for Microsoft
Now that the year is off and running, the Morgan Stanley team thinks things are looking up for Microsoft. They said the company is entering the year with “real top-line drivers,” better margins and strong capital returns. Further, they believe the risk from the weakening PC market is much less than it was before, with the More Personal Computing segment, which includes Windows and the Nokia mobile devices, is now only 15% of the company’s total operating income.
Also it has about a 3% dividend yield, and earnings are expected to see a compound annual growth rate of about 10% between fiscal 2016 and 2018. These metrics derive a total return of about 13%, representing a premium to the S&P’s 8% return. As a result, Morgan Stanley analysts are expecting to see Microsoft’s multiple expand.
Strong returns seem likely
They further explained why the company seems poised to post mid-teen returns this year. For one thing, they remain confident in a 7% compound annual growth rate for revenue between fiscal 2016 and 2018. Among the top-line growth drivers are Azure, which is enabling Microsoft to transform into a winner in the public cloud market. Also share gains and strong pricing trends in data centers and user base and pricing increases in Office 365 are boosting the Redmond, Wash.-based tech giant’s revenue opportunities.
All of these positives stack up well to the weights of Windows and Nokia, both of which are easing as the company relies less upon them for sales.
Margins on the mend
The Morgan Stanley team expects Microsoft’s operating margins to keep expanding every year through fiscal 2018. Management has been controlling operating expenses well, and the analysts predict a 1.7% compound annual growth rate through fiscal 2018 for operating expenses compared to the expected 7% growth rate in revenues. After five years of declining operating margins, they now expect growth of about 50 basis points per year over the next three years.
The company’s gross margins have also been improving thanks to success in the public cloud, which carry better gross margins and help offset the mix shift.
Microsoft gets serious about capital returns
And finally, the Morgan Stanley team notes that Microsoft has begun an aggressive capital return program. Shareholders at most major tech companies have been wanting to see more of their capital returned to them, so this move is sure to interest investors.
Over the last five years, the company has upped its dividend by about 18% on average per year, and the analysts expect this trend to continue as earnings growth returns. Also by borrowing against its offshore cash, the company can cut down the number of diluted shares at a compound annual growth rate of 3.6% through fiscal 2018. Last year only Apple bought back more shares than Microsoft did.
Shares of Microsoft opened higher today but then edged lower as the day wore on. The stock is up by 0.06% at $52.81 per share as of this writing.