Microsoft beats king dollar and rising interest rates
Despite the problems, big tech stocks are incredibly resilient investments. With the global economy facing inflation, war in Ukraine and a possible recession in 2023, many tech and software stocks continue to climb. Microsoftit is (MSFT 4.02%) The results for the first quarter of fiscal 2023 illustrate this resilience.
But the pressure is mounting. A record surge in the US dollar is only beginning to send corporate profits skyrocketing. Microsoft is going to be more than fine, but a big speed bump is looming.
King Dollar demands a haircut
Just like other cloud computing giants that reported earnings (Amazon (AMZN -6.80%) Web services and Alphabetit is (GOOGL 4.41%) (GOOG 4.30%) Google Cloud), Microsoft reported a surprising negative effect of exchange rates. In the first quarter of its fiscal year 2023 (the three months ending September 30, 2022), total revenue increased 11% year-over-year to $50.1 billion.
However, taking into account the effects of exchange rates, revenues would have increased by 16%. Thus, King Dollar took a heavy toll of five percentage points.
This is a challenge for any American multinational organization at this time. Here’s how it works: A sale is made outside the United States and collected in that country’s currency, but the money received must be converted back to US dollars for reporting purposes. So far, not much. But what happens when the dollar appreciates against this foreign currency? Suddenly, the value of this international sale is reduced when exchanged for a stronger dollar.
This is all an unpleasant side effect of the US Federal Reserve’s aggressive interest rate hikes this year. Other central banks have been slower to raise rates in their fight against inflation compared to the Fed’s record pace of hikes, which caused the dollar to rise in value by double digits this year.
So the problem of Microsoft and its friends right now. Revenue growth is still intact, but currency exchange rates significantly reduce reported financial numbers.
A growth stock for nearly 40 years and still counting
The record high dollar is even more demanding on profit margins. Again, like other tech titans, the majority of Microsoft’s spending is done in US dollars. So when these expenses are made in a strengthening currency relative to income received in a weakening international currency, the effect is an even greater reduction in profitability. While the dollar suffered a five percentage point reduction in Microsoft revenue last quarter, it suffered a whopping nine percentage point reduction in operating profit – bringing back year-on-year operating profit growth on the other at 6% (compared to growth of 15% excluding currency effects). Ouch!
The good news, however, is that even after nearly four decades as a publicly traded company, Microsoft is still a growth stock. As CEO Satya Nadella said in the earnings report: “In a world facing increasing headwinds, digital technology is the ultimate tailwind.” When software is done right (coupled with sticky hardware products that we can’t separate our lives from), it becomes an incredible growth investment for many decades. With inflation and economic uncertainty being the story of the year, Microsoft continues to help its users “do more with less” in new ways.
Of course, these currency headwinds are likely to continue into Microsoft’s second quarter of 2023 and will likely continue through the rest of the fiscal year. Additionally, the accelerating global economic slowdown is also impacting Microsoft’s currency-neutral growth. The Azure cloud segment, the main driver of earnings these days, is expected to slow from a growth rate of 42% year-over-year (ex-FX) to around 37% (also currency neutral) in the second quarter of fiscal 2023.
While these various factors are cause for concern, it’s clear that Microsoft is far more resilient than the average mega-corporation. The shares are trading for 24 times trailing 12 month earnings per share, which seems like a fair value to me assuming the company can grow earnings per share to a mid-high to low-single-digit percentage for the teens for the rest of the 2020s. After all, at some point, the strength of the dollar will dissipate – perhaps even reverse – which would boost Microsoft’s revenue and profits.
This market will continue to be wild, but Microsoft seems like a good safe haven to hold for the long term.
Suzanne Frey, an executive at Alphabet, is a board member of The Motley Fool. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a board member of The Motley Fool. Nicholas Rossolillo and his clients have positions in Alphabet (C shares) and Amazon. The Motley Fool owns and recommends Alphabet (A shares), Alphabet (C shares), Amazon and Microsoft. The Motley Fool has a disclosure policy.