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How the PC slowdown could impact Microsoft and what it means for our investment thesis

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Microsoft (MSFT)’s PC business is likely to be a weak spot when the Club holding reports earnings next week — but it might not drag down the company’s overall results as much as some fear, according to Bernstein analyst Mark Moerdler. While we’d welcome that development, we’re realistic about the challenges in PCs right now. In a note to clients Monday, Bernstein dove deep into Microsoft’s Windows business after declining PC shipment data sparked renewed worries about its implications for the tech giant. However, the firm made the case that Microsoft’s cloud computing shift — the core part of the Club’s investment thesis — should help cushion the blow to fiscal 2023 first-quarter numbers. “Windows was always been an important part of the company, its franchise, and results. But with the shift to Cloud, Windows has a become less critical driver of revenue and earnings,” Bernstein wrote, adding that Windows has lately seen slower growth with “with consumer Windows having lost share.” “That does not mean that it is not important and that PC weakness will not impact results, but we do not believe the impact will be as large as some may believe,” the analyst said. “In addition, Microsoft had already baked in weakness into their guidance.” In July, Microsoft said it expected between $13 billion and $13.4 billion in revenue for its “More Personal Computing” segment in the first quarter. At the time, that guidance was below the $13.82 billion estimate, according to FactSet. Analysts are now expecting $13.22 billion in “More Personal Computing” revenues, according to FactSet. Details of Bernstein’s case Bernstein listed a number of reasons why it thinks Microsoft won’t be hit with the worst-case PC scenario, including that the most pronounced weakness so far has been in lower-end consumer machines. That’s notable, the analyst argued, because “most of Microsoft’s OEM revenue is from commercial and high-end PCs.” By contrast, Bernstein estimates only around 20% of Windows revenue comes from consumer PCs. There could also be a timing component at play that investors should keep in mind. The analyst explained that Microsoft records revenue when PCs using its Windows operating system are boxed and shipped from the manufacturer — not when sold to a consumer. “In other words weakness in calendar Q3 may not be felt until Q4 or later depending on channel inventories,” Bernstein wrote. Moreover, Bernstein said an increasing portion of Windows revenue falls under the annuity model, which includes sales of subscriptions that feature Windows as well as Office productivity software. The revenue in this area is not necessarily linked to the number of PCs sold each year. Club take The decline in PC sales after a few booming years during the Covid pandemic has been on our radar for months. We knew it could weigh on Microsoft in the near term as sales normalize a bit. However, Bernstein made an interesting case about the makeup of Windows revenue, and we see how the analysts could conclude that Microsoft won’t be the hardest hit by the PC slowdown. In this market, we need to keep our expectations in check and be mindful that conditions are constantly changing — not always for the better, as we saw with Club holding Advanced Micro Devices (AMD). The chip designer chose to issue preliminary third-quarter results earlier in the month due to weaker-than-expected PC sales, even after management revised lower its industry outlook in early August. Perhaps more importantly for Microsoft, we remind Club members that our primary reason for investing in the company is its Azure business. The cloud computing service — which hosts websites and software applications — is the main long-term growth driver, underpinned by secular trends toward digitization. That is in contrast to PC hardware sales, which we understand are more cyclical in nature. Similarly, when Microsoft reports on Oct. 25 after the bell, we expect to hear a lot about challenges associated with the strong U.S. dollar. That’s been a problem for the tech giant in recent months because it generates roughly 50% of its revenue outside the U.S. When earnings booked overseas in weaker currencies are converted into U.S. dollars, it can cut into profits. The U.S. Dollar Currency Index, which measures the greenback against a basket of foreign currencies, is even higher now than it was in late July, when MSFT last reported earnings . While currency headwinds have a real effect on the company, we don’t really factor them into our long-term investment decisions because they’re unpredictable and can be cyclical, too. We’re aware of them, so we can prepare for all possible outcomes for companies in which we’re shareholders, but they’re not central to our investment thesis like cloud-computing growth is for Microsoft. Next week, we’ll be paying close attention to Microsoft’s cloud results and management’s commentary on the overall enterprise spending environment in the face of economic downturn. A global recession is definitely one of the biggest near-term risks to Microsoft’s results, so we’ll want to hear how Microsoft’s clients are acting. Another thing to keep in mind ahead of the quarter is that Microsoft only provides formal guidance on its earnings conference call. Oftentimes, the stock may go one way in extended trading after the quarterly numbers are released, before turning around based on the guidance. That’s why paying attention to the call is so important in reaching a conclusion. (Jim Cramer’s Charitable Trust is long MSFT and AAPL. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

Satya Nadella, chief executive officer of Microsoft Corp.
David Paul Morris | Bloomberg | Getty Images

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