AnryMos
Elevator Pitch
I have a Buy investment rating for Microsoft Corporation’s (NASDAQ:MSFT) shares.
I evaluated MSFT’s five-year or medium-term prospects with my prior September 6, 2022 write-up. I turn my attention to Microsoft’s recent layoffs with this current update.
MSFT is reported to have laid off some of its workers recently, and this is consistent with the company’s guidance of keeping headcount stable in the near term. In view of the company’s expense management initiatives such as those relating to headcount, Microsoft is guiding for a “double-digit” increase in its FY 2023 (YE June 30) operating profit. Despite the reasonably good management guidance for the current fiscal year, MSFT’s forward EV/EBIT and P/E valuation multiples are now close to their respective three-year historical lows. As such, I judge Microsoft’s shares to be undervalued and assign a Buy rating to the stock.
How Many Workers Is Microsoft Laying Off?
Microsoft reported the company’s financial results for the first quarter of fiscal 2023 last week (October 25), and management’s comments at MSFT’s recent quarterly earnings call on the same day brought investor attention to its layoffs.
At its Q1 FY 2023 investor briefing, MSFT guided that “our sequential headcount growth from Q1 (FY 2023) to Q2 (FY 2023) will be minimal.” In other words, Microsoft’s guidance implies that there won’t be a meaningful increase in the company’s number of employees between September 30, 2022, and December 31, 2022.
Earlier, an October 18, 2022, Seeking Alpha News article cited a Wall Street Journal report which mentioned that Microsoft “laid off nearly 1,000 employees across multiple divisions.”
MSFT Stock Key Metrics
There are a few metrics which investors should watch in relation to Microsoft’s recent layoffs and its target of keeping its headcount stable on a QoQ basis for Q2 FY 2023.
The company only reveals its official employee numbers once every year with its 10-K filings. MSFT previously disclosed in its FY 2022 10-K filing that it “employed approximately 221,000 people” as of the end of the first half of this year. This suggests that Microsoft is laying off around 0.5% of its workforce.
Notably, Microsoft’s total number of employees grew by a significant +22% in FY 2022 as compared to its staff strength of 181,000 as of end-FY 2021. The substantial increase in MSFT’s headcount was driven by both M&A transactions (acquisition of Nuance and Xander) and a faster pace of recruitment for its existing businesses.
The growth in headcount also coincided with an increase in operating costs. Specifically, Microsoft’s research and development, sales and marketing, and general and administrative expenses rose by +18%, +8%, and +16%, respectively for FY 2022.
Why Is Microsoft Laying Off Workers?
MSFT’s key metrics highlighted in the preceding section help to provide an understanding of why Microsoft is laying off workers. Both the company’s number of employees and operating expenses are rising, and this isn’t favorable considering the challenging economic environment.
Microsoft emphasized at its Q1 FY 2023 earnings briefing that the company aims to “use those (additional) headcount in the most productive way possible.” More importantly, MSFT stressed at the most recent quarterly results call that it “will be disciplined in managing our cost structure” to “respond to the macro.”
The company’s efforts in slowing the pace of recruitment have already paid off to some extent in the first quarter of the current fiscal year. As indicated in its most recent quarterly earnings presentation, Microsoft’s actual Q1 FY 2023 operating costs amounted to $13.2 billion and turned out to be lower than its prior management guidance in the $13.3-$13.4 billion range. This was a key factor that contributed to MSFT’s +2% earnings beat for the first quarter of fiscal 2023.
What Is Microsoft’s Business Outlook Now?
In tandem with its Q1 FY 2023 financial results announcement, Microsoft offered its guidance for full-year fiscal 2023.
As per its press release and outlook presentation, Microsoft expects that the rate of increase for its operating costs will “moderate materially through the year (fiscal 2023)” which should translate into a 1% decline in its operating profit margin for FY 2023. MSFT attributed expectations of a slower pace of growth in operating expenses for the year to the company’s “focus on growing productivity of the significant headcount investments we’ve made over the last year” at its Q1 FY 2023 earnings call.
It is worthy to note that MSFT’s guidance points to a “double-digit revenue and operating income growth on a constant currency basis” for the company in full-year fiscal 2023 as per its management comments at the recent quarterly earnings briefing.
In my view, it is encouraging to see Microsoft striking a good balance between maintaining short-term profitability and investing to drive long-term growth.
Microsoft’s expected “double-digit” increase (I assume that this will be in the low-teens percentage range) in operating profit for FY 2023 is very likely to be inferior to the company’s actual +21% constant-currency operating income growth in FY 2022, but an operating profit expansion of above +10% will still be pretty good in this tough economic environment.
It is reasonable to assume that MSFT could have guided for much stronger growth in FY 2023 operating income, if it chose to cut back on investments and reduced its headcount to a larger extent. As I mentioned earlier in this article, Microsoft is reported to have laid off about 0.5% of its total employees, and it is only targeting a stable (rather than a substantial reduction) headcount going forward.
This particular question-and-answer at the company’s first quarter investor call sends a clear signal that Microsoft won’t sacrifice long-term growth to sustain short-term profitability at all costs. An analyst from UBS (UBS) questioned why Microsoft “elected not to throttle back OpEx (Operating Expenses)” despite “the weakness on the Windows side.” In response, Microsoft’s CFO Amy Hood replied that “it’s important to stay consistent in this down market” and “continuing to invest where we’re seeing substantial opportunity and growth.”
In a nutshell, I have a favorable opinion of Microsoft’s business outlook. In the short term, MSFT has done layoffs and slowed the pace of new hiring with the aim of managing its costs and maintaining a healthy level of profitability. But MSFT’s intermediate-to-long term prospects aren’t affected, because the company is not pulling back on its investments in areas which have good growth potential in the long run.
Is MSFT Stock A Buy, Sell, or Hold?
MSFT stock continues to warrant a Buy rating in my view. Microsoft’s near-term outlook is decent judging by the company’s management guidance for operating profit growth, and its valuations are appealing.
MSFT’s current valuation multiples are nearing their three-year historical lows. The market is now valuing Microsoft at a consensus forward next twelve months’ normalized P/E multiple of 23.1 times as per S&P Capital IQ data, which is merely +4% higher than its historical three-year trough P/E ratio of 22.2 times. Similarly, MSFT’s current consensus forward next twelve months’ EV/EBIT metric of 18.4 times is only +3% above its three-year EV/EBIT low of 17.8 times.
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