As Microsoft (NASDAQ: MSFT) approaches its fiscal first-quarter earnings report, Citigroup has revised its twelve-month price target for the tech giant, lowering it from $500 to $497.
Despite the lower target, Citigroup maintains a ‘Buy’ rating on the stock. The revision reflects concerns over rising capital expenditures and slower growth in Microsoft’s cloud computing division, Azure, which has underperformed expectations in recent quarters.
Currently, Microsoft stock is trading at $428.93, showing a 1.5% rise over the past five days and a modest 1% gain over the past month.
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AI investments drive capital expenditure concerns
Microsoft’s market performance has been relatively tepid compared to the broader tech sector. Since late April, Microsoft’s stock has risen by only about 5%, significantly lagging behind the Nasdaq’s 18% gain during the same period.
One major factor contributing to this slower growth is the company’s increasing capital expenditures, which are projected to rise by 36% year-on-year to $55.7 billion in 2024.
For instance, in the fourth quarter of FY2024, which ended in June, Microsoft’s capital expenditures reached $19 billion, with nearly all of it allocated to artificial intelligence (AI) and cloud-related spending.
This investment is focused on building and leasing data centers, which the company expects to monetize over the next 15 years, as well as acquiring servers (CPUs and GPUs) to meet the increasing demand for AI and cloud services.
As AI drives higher energy consumption, Microsoft has also taken steps to secure reliable energy sources, such as its September deal to restart the Three Mile Island nuclear reactor in Pennsylvania.
While these investments position Microsoft for future growth, concerns remain about their short-term impact on profitability. Citigroup analyst Tyler Radke expressed reservations about Microsoft’s heavy spending on AI initiatives, noting that these investments have yet to generate the expected returns.
“Microsoft shares have lagged as investors grapple with the sharp increase in capital spending alongside underwhelming Azure growth,” Radke said.
Radke also highlighted that Microsoft’s earnings could face headwinds in the near term due to the capital expenditure surge and Azure’s underperformance.
Azure’s underperformance dampens optimism
Azure, Microsoft’s cloud computing division, has historically been a key growth driver. However, recent performance has fallen short of expectations, with internal capacity constraints and broader economic challenges slowing its growth.
This underperformance was particularly noticeable in Microsoft’s fiscal fourth quarter, which gave mixed results.
Meanwhile, investors are also closely monitoring other segments, such as Dynamics 365 and the Power Platform. Notably, Dynamics 365, Microsoft’s CRM and ERP solution, posted a 19% revenue increase in the previous quarter, boosting overall Dynamics revenue by 16%.
The Power Platform, which includes tools like Power BI, Power Apps, and Power Automate, also experienced substantial growth, with over 48 million monthly active users and a 40% increase year-on-year.
Analyst reactions and forecasts
Despite Citigroup’s lowered price target, Microsoft continues to receive strong support from Wall Street analysts. For instance, Loop Capital’s Yun Kim reiterated a ‘Buy’ rating with a $500 price target ahead of Microsoft’s Q1 results.
Kim expects a “solid” quarter, with key growth drivers showing modest acceleration. The firm also notes that recent industry checks indicate a slight improvement in IT spending, which could support further growth into the end of 2024.
In summary, Citigroup’s decision to lower Microsoft’s price target ahead of earnings highlights growing concerns over capital expenditure and Azure’s slower-than-expected growth.
However, despite these short-term challenges, analysts remain bullish on Microsoft’s long-term potential, particularly as the company continues to integrate AI across its product offerings and expand its cloud services.
