21 January 2007

MSFT: Analysis through Sept 2006

Since the fiscal year for software colossus Microsoft ends on 30 June, the quarter that ended on 31 December 2006 was the second quarter of fiscal 2007. Microsoft will report their results for this quarter on 25 January. We are preparing for this report by reviewing the analysis we performed last October after Microsoft issued their data for the fiscal 2007's first quarter. We will also identify data in the 2nd quarter results that would provide an initial indication into the strength or weakness of Micosoft's performance.

With the data for the quarter ending 30 September, our Cash Management gauge for Microsoft displayed 9 out of 25 total points. However, this gauge isn't particularly meaningful for Microsoft because Inventory has only recently become consequential (mostly xboxes?) and Long-Term Debt is neglible. The Current Ratio was an ideal 2.1; it has come down from previous ridiculously high levels as cash was spent on stock buybacks. Accounts Receivable were 55 days of Revenue, a little less that its long-term average.

The Growth gauge showed 12 points. Revenue growth was 12 percent year over year, after having slumped to single-digit percentage points in 2005. Net Income growth, on the other hand, has continued to spiral downward to an anemic 1 percent. The pressure on Net Income appears to be due, in part, to higher income taxes and less interest income (since cash that was earning interest has been spent on stock buybacks). Cash Flow from Operations (CFO) has actually declined by a substantial 16 percent on a year-over-year basis. Revenue/Assets moved up to 69 percent. This also appears to be the result of the company drawing down its cash levels to buy shares of its common stock.

Profitability scored 11 of 25 points. The Return on Invested Capital (ROIC) skyrocketed to 43 percent, its highest level in 6 years; the increase is also partly explained by reduction in stockholders equity after share repurchases. Free Cash Flow (FCF) to Equity edged up to 34 percent. Since CFO and FCF have been decreasing, as mentioned in previously,the FCF/Equity performance must be attributed to the reduction in the number of shares outstanding. Operating Expenses as a proportion of Revenue has been a stable 63 percent, as a slight downtrend in Gross Margin has been compensated by reduced SG&A expenditures. The Accrual Ratio moved above zero percent for the first time in more than a decade. This unhappy result, signifying lower-quality earnings, is because the decline in CFO means that a growing proportion of Net Income has been due to non-operating factors (i.e., changes in accruals).

The Value gauge read a healthy 15 points. The Price/Earnings ratio at the end of September was 21. This is a much lower than its historical average, suggesting greater value. Similarly, with the P/E ratio at a value that is 36 percent above the S&P 500 market multiple, we see a much lower premium. On the other hand, the PEG ratio has soared because earnings growth was a mere 1 percent. The Price/Revenues ratio was a seemingly scary 6.0, but this is actually a tad lower than historic values.

Rolling up all of the above, the Overall gauge came in with a score of 50 out of 100 points. In other cases, this would be a good, if not very good, score; however, the score was a fabulous 70 in mid 2005. We'd like to think that last year's scores foretold recent gains in the stock price. But, if we believe this, we shouldn't expect the gains to continue for long.

Things to look for in the results for the quarter ending 31 December:

Revenue: Is revenue growth maintaining a double-digit pace? The Wall Street estimate is $12.1 billion for the quarter. Our model predicts a more modest $11.9 billion. The lower value would still result in a 10 percent year-over-year revenue growth.

Operating Expenses: Has increased spending degraded the ratio of operating expenses to revenues below 63 percent.

Net Income: The market estimate is 23 cents per share for the quarter, which is a significant drop. We suspect the market is aware of non-recurring expenses (stock-option expenses????) depressing net income. Our estimate is a more robust 33 cents. We'll carefully scrutinize the new financial report to figure out why the market expects such weak earnings -- and yet it has been pushing up the stock price.

CFO: We'd like to see CFO start growing again.

No comments:

Post a Comment