Microsoft Corporation (MSFT) Stock Is Going to $80 in 2017

MSFT - Microsoft Corporation (MSFT) Stock Is Going to $80 in 2017

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Piper Jaffray analyst Alex Zukin recently initiated coverage on Microsoft Corporation (NASDAQ:MSFT) with an “Overweight” rating and a 12-month price target on MSFT stock of $80, which is 26.7% higher than its current price.

Microsoft Corporation (MSFT) Stock Is Going to $80 in 2017

Zukin thinks MSFT is going to $80 in 2017, but ultimately it will come down to the company’s cloud business and whether it will deliver a fifth consecutive year of double-digit total returns after badly trailing its technology peers for many years prior to its resurgence in 2013.

In a note to clients, Zukin wrote:

“The central tenet of our investment thesis and $80 price target is the belief that Microsoft’s fast-growing Cloud businesses will lead to accelerated revenue and gross profit growth through FY19. We model a Cloud revenue CAGR of 33% through FY19 (which we define as revenue from Azure, Office 365 (commercial + consumer), LinkedIn and a portion of the Dynamics franchise) with Cloud going from 11.5% to 30.6% of Total Revenue while at the same time Cloud Revenue gross margins expand from 42% to 60%.”

More revenue at higher gross margins leads to increased profits, which drive stock prices higher.

Wall Street Analysts Love MSFT Stock

Analysts just can’t get enough of MSFT stock. Out of 36 analysts covering Microsoft, 26 rate it a buy, with just two recommending investors sell Microsoft.

Although the median estimate price target for Microsoft stock is $68, and well off Zukin’s $80 prediction, it’s within shouting distance of other enthusiastic investment professionals.

Morgan Stanley analyst Keith Weiss pegs the 12-month target price for Microsoft stock at $74 with an “Overweight” rating, citing its huge share buyback program as one of the catalysts to move MSFT higher. Over at Merrill Lynch, Kash Rangan has named MSFT one of the top three large-cap stock picks for 2017.

But, it’s not only analysts who love Microsoft.

Investors, too, have an affection for MSFT stock. Currently yielding 2.47%, the company has increased its dividend for 13 consecutive years, making it one of the more attractive dividend-paying S&P 500 stocks.

As for those share repurchases that Weiss mentioned, Microsoft’s board approved another $40 billion buyback program in September that will continue to reduce the company’s share count, which has dropped by 19%, or 1.9 billion shares, over the past decade. Historically, MSFT has done a good job buying back its stock at reasonable prices. It’s definitely one of the better stewards of shareholder capital in America.

Higher Gross Margins

As recently as fiscal 2010, Microsoft had 80% gross margins, and in fiscal 2016, they were 61.6%, significantly lower than earlier in the decade. But, if Zukin is right and Microsoft’s cloud business grows to 30% of revenue by fiscal 2019, and gross margins increase to from 42% to 60% (even if the rest of its business doesn’t grow), Microsoft’s gross margins should increase at a nice rate.

In the first quarter of fiscal 2017, Microsoft’s commercial cloud business had a revenue run rate of approximately $13 billion, or $3.3 billion for the quarter, which represents approximately 15.9% of overall Q1 2017 revenue.

The problem with that number is that it also includes non-cloud software-as-a-service revenue from Office 365. Zukin says it is closer to 11.5% of overall revenue.

Let’s go with that.

Fast Forward to 2019

In fiscal 2016, Microsoft’s three business segments generated $92.0 billion in revenue, excluding revenue deferrals. If the cloud was responsible for $10.6 billion of that (11.5% of overall revenue) the remainder would account for $81.6 billion.

Fast forward to the end of fiscal 2019.

Assuming no growth for the rest of Microsoft’s business, while the cloud accounts for 30% of overall revenue, cloud revenue would be approximately $35 billion. So, gross profit from the cloud would go from $4.5 billion ($10.6 billion times 42% gross margins) in fiscal 2016 to $21 billion ($35 billion times 60% gross margins) in fiscal 2019, a 366.7% increase over three years.

Not too shabby.

Now, if the gross profit for the cloud in fiscal 2016 was $4.5 billion, the gross profit for the remainder of the business would have been $48 billion, or a gross margin of 63.6%. If the numbers for the rest of the business stay the same and the cloud increases by the amount above, Microsoft’s gross margin in fiscal 2019 should be almost 100 basis points higher, perhaps more (considering that my calculation is a very back-of-the-napkin exercise).

Needless to say, increasing profits, higher dividends and a higher price for MSFT stock (assuming the overall markets are higher) are all but certain for 2017 and beyond.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

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