Microsoft Corporation (NASDAQ:MSFT) is getting some much needed love today. Barclays upgraded their opinion on the NASDAQ 100 company to an "Overweight" from an "Equalweight" rating.
Raimo Lenschow puts a price target of $42 on the monster-sized software company. He says MSFT is likely to choose a CEO internally and that the decision to stay in-house allows investors to focus on the company's improving fundamentals.
Like you don't know, but just in case, Microsoft Corporation is engaged in developing, licensing and supporting a range of software products and services. The Company operates in five segments: Windows & Windows Live Division (Windows Division), Server and Tools, Online Services Division (OSD), Microsoft Business Division (MBD), and Entertainment and Devices Division (EDD).
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Lenschow says, "In our opinion, the market is now pricing in a lower probability that an outsider will be named as CEO, especially with this week's confirmation that Alan Mulally is no longer in the running. While a further negative reaction is possible if an internal candidate is selected, we would see such a scenario as a buying opportunity, as the underlying fundamentals, discussed above, continue to improve. We think this will already be evident in the upcoming quarterly results (published January 23)."
To justify his new opinion, the analyst wrote change, "Gartner estimates cloud services to be a ~$200bn market by 2016. Microsoft has now fully embraced this trend and is already seeing credible success in cloud services with Azure (~$500m revenue in 2014 at +100% growth) and Office 365 ($1.5bn run rate). We estimate that cloud services could generate close to 10% of total revenue by 2017 and represent an ongoing significant growth driver for the company."
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Lenschow believes some expectations could be too low and prove to be a catalyst, "The main challenge for MSFT remains consumer Windows, where the move to mobile is quickly eroding growth. However, expectations around devices (i.e., Surface and Lumia) are now so low that upside could start to show in the coming quarters, while Windows comps are also getting easier."
It could be a whole lot better for Microsoft if they could cut back on the cost of revenue. Last quarter, the income statement line item increased at 22.70% while revenue climbed 15.75%.
However, management was able to offset the increase by reducing general and administrative expenses. As it was, cost of revenue plus operating expenses grew at a slower rate than sales, which means higher margins.
The balance sheet has a major plus and a major minus, in our view. As they say, the bad news first; inventory jumped 34.83%. Rising inventory doesn't necessarily translate into problems right away, but could turn into big-time trouble if the trend continues.
Now the good balance sheet news. Accounts receivables dropped a dramatic 37.05%, which means Microsoft's customers are paying up – a healthy sign.
Fundamentals will have to improve, or the company's multiples will have to expand for MSFT to hit Lenschow's $42. As we type, Mr. Softy's price-to-earnings (P/E) ratio is 13.34, which is running slightly warmer than the five-year average of 13.01.
We find a similar scenario on a price-to-sales (P/S) basis. Wall Street has been willing to pay an average P/S ratio of 3.56 for the Window's company during the last half-decade. Today, MSFT is trading at 3.76 times.
Overall: Microsoft Corporation's (NASDAQ:MSFT) stock is valued in the middle of the road. If Lenschow is correct that fundamentals are one the verge of improving and if margins can continue to climb, then it could be a one-two punch that helps accelerate profits faster than the street anticipates. Multiples tend to expand when profits outpace expectations.
The only worry in our view is bloating inventory. If that issues goes away, then MSFT shares could blow past $42.
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