27 July 2009

MSFT: Financial Gauge Scores for the June 2009 Quarter

In an earlier post, we examined Microsoft's (NASDAQ: MSFT) Income Statement for the June quarter and compared the figures to our "look-ahead" estimates.  Earnings fell from $0.46 per share to $0.34 in this fourth quarter of Microsoft's fiscal year 2009.

We have since mined the financial statements in Microsoft's earnings announcement to update the metrics we use to assess Cash Management, Growth, Profitability and Value.  This post reports on these metrics and the Financial Gauge scores.

If necessary, we will update the analysis results after Microsoft files its 10-K report for the year with more detailed information.

In summary, Microsoft's latest GCFR gauge scores are as follows:
  • Overall: 61 of 100 (down from 69)

The current and historical values for the financial metrics that determine the gauge scores are listed below, with some brief commentary.

Cash Management Jun 2009 Mar 2009 Jun 2008 5-Yr Avg
Current Ratio 1.8 1.7 1.4 2.1
LTD/Equity 9.5% 0.0% 0.0% 0.0%
Debt/CFO (years) 0.3 0.1 0.0 0.0
Inventory/CGS (days) 25.6 21.0 33.2 39.2
Finished Goods/Inventory N/A 0.6 0.5 0.7
Days of Sales Outstanding (days) 77.4 56.8 75.3 60.3
Working Capital/Invested Capital 161% 124% 106% 254%
Cash Conversion Cycle Time (days) -10.0 -20.2 -7.5 -1.0
Gauge Score (0 to 25) 21 16 14 17

In its first bond offering, Microsoft sold debt securities worth $3.75 billion in May 2009.  Since the company has over $31 billion in Cash and Short-term investments on its Balance Sheet, and since Cash Flow from Operations averaged $4.76 billion per quarter in fiscal 2009, the debt is not especially significant.  Microsoft has, however, exercised a means of raising larger amounts of cash should management, for example, decide to pursue a large acquisition.

Microsoft joined the elite ranks of non-financial entities with AAA rating bond ratings, which is the highest S&P grade, last September. 

We're curious if there is an issue involving Accounts Receivable, which is reflected in the Days of Sales Outstanding metric.  Shorted periods are preferred because it indicates the company is getting paid faster.  The increase shown in the table above got our attention, but the bigger concern might be that the Allowance for Doubtful Receivables spiked unprecedentedly in the last quarter from $242 million to $451 million.  Is a big customer slowing payments?

Growth Jun 2009 Mar 2009 Jun 2008 5-Yr Avg
Revenue growth -3.3% 5.6% 18.2% 10.8%
Revenue/Assets 77.6% 87.6% 88.9% 71.1%
Operating Profit growth 13.7% 18.0% 21.8% 15.8%
CFO growth -11.9% -12.1% 21.4% 9.0%
Net Income growth -17.6% -3.6% 25.7% 8.8%
Gauge Score (0 to 25) 1 5 22 16
Revenue, CFO, and Net Income growth rates compare the last four quarters to the four previous quarters.
The Operating Profit rate is the annualized rate of growth in Operating Profit after Taxes over the last 16 quarters.

The 3.3-percent drop in Revenue during the last four quarters was the first time Microsoft's Revenue fell from one fiscal year to the next.

Fiscal 2009 was also the first year since 2002 in which Net Income declined. 

Profitability Jun 2009 Mar 2009 Jun 2008 5-Yr Avg
Operating Expenses/Revenue 64.6% 63.5% 63.1% 63.5%
ROIC 115% 132% 163% 139%
Free Cash Flow/Invested Capital 120% 127% 182% 163%
Accrual Ratio 14.5% 7.2% 0.9% -8.3%
Gauge Score (0 to 25) 12 13 12 17

The Operating Expense ratio above was negatively affected by the lower margins on software for inexpensive netbooks and the decline in Revenue.  However, Microsoft's cost-cutting actions announced at the beginning of the year have gained traction and should help reduce the expense ratio in the future.

Although the ROIC and FCF/IC ratios are still impressive, their significant declines in the last year should be considered.

Value Jun 2009 Mar 2009 Jun 2008 5-Yr Avg
P/E 14.6 10.3 14.6 19.6
P/E vs. S&P 500 P/E 0.7 0.6 0.8 1.2
PEG 1.1 0.6 0.7 0.6
Price/Revenue 3.6 2.7 4.3 5.6
Enterprise Value/Cash Flow (EV/CFO) 9.8 7.3 10.8 12.7
Gauge Score (0 to 25) 18 25 19 15

Microsoft's stock price rebounded 29 percent during the April-June quarter, from $18.37 to $23.77, and this, coupled with the last quarter's weak results, ended Microsoft's time with a perfect 25-point Value gauge score. Nevertheless, 18 points is still a very good result.

These ratios for Microsoft can be compared with other companies in the Application Software industry.

Overall Jun 2009 Mar 2009 Jun 2008 5-Yr Avg
Gauge Score (0 to 100) 61 69 65 64

We will conclude with one more ratio.  At the end of June, Microsoft's Market Value was about $212 billion.  Cash Flow from Operations in fiscal 2009, a challenging year for the company, was $19 billion.  Therefore, the Price/Cash Flow ratio was about 11.  The inverse of this number indicates that each dollar to purchase a share of Microsoft returns 9 cents in annual cash flow. 

Full disclosure: Long MSFT at time of writing.

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