Microsoft – FX Really?

The strangest profit warning.

• Microsoft has been forced to downgrade its earnings forecast less than one month after it gave it in what is both a complete non-story but also makes me wonder whether something else is going on here.
• On 26^th April 2022, Microsoft said that FQ4 22 revenue / EPS would be $52.4bn – $53.2bn / $2.28 – $2.35 which is a pretty tight range exemplifying a company that is more than on top of its financial systems.
• However, on 2^nd June 2022, Microsoft was forced to file an S-8 with the SEC as its new expectations were indicating that revenues could be outside of the guided range.
• The new FQ4 22 revenue / EPS range is $51.94bn – $52.74bn (a reduction of $460m) / $2.24 – $2.32 (down $0.03) representing a 0.8% reduction in revenues and a 1.7% reduction in EPS.
• In the grand scheme of things, this reduction is completely and utterly irrelevant because forecasting is a very uncertain business, and a fluctuation of this size is meaningless.
• However, Microsoft is blaming the strength of the US dollar versus other currencies as the sole reason for the change which strikes me as very strange.
• This is because on 26^th April the DXY (index of the USD against a basket of other major fiat currencies) stood at 102.2 and on the 2^nd June (date of filing) the DXY stood at 101.6.
• To be fair to Microsoft, during the month of May the DXY climbed all the way to almost 105 before Madame Lagarde discussed interest rate rises by the ECB sending the Euro back up and the DXY back down to where it is today.
• Consequently, between the time of the S-8 and the original forecast, the DXY index remains almost unchanged making me wonder where the downgrade is coming from.
• On April 26^th Microsoft would have been aware of the DXY’s strong rally from 90 in mid-2021 and so this would have been included in its forecasts.
• Furthermore, the forecasts it gave on April 26^th would have reflected the dollar level at the time which was around 102 and since that time until today, nothing has changed.
• Consequently, there are two choices.
• Either Microsoft’s forecasting, reporting and financial management are not as good as I thought or something else is causing the weakness.
• Snap has already warned of weakness in its business in the calendar second quarter (see here) which makes me wonder whether Microsoft is experiencing similar issues albeit at a much lower level.
• Microsoft is operating in a very different market to Snap and I suspect that enterprise will be more resilient to inflation than digital advertising but I can’t help wondering whether this is a sign of a really tough quarter ahead.
• Much of the technology sector has corrected meaningfully off its highs but only a few of the valuations are at levels where one could make a case for a value-based investment.
• Hence, if the economy is already in recession, then we can expect another very difficult quarter ahead.
• This will trigger further corrections in the technology sector which will be led by the highest valued companies.
• Many of these have already fallen by 70% or more but their valuations indicate that they could halve again without difficulty if things get tougher.
• Hence, I would stick with the value end of the sector and semis in particular as these remain in short supply which is not going to be alleviated imminently.
• Here I continue to favour Qualcomm, TSMC and MediaTek as companies with reasonable growth ahead, strong positions in their markets as well as valuations that are less than 15x 2022 PER.
• It is this lot that will fall the least if there is another round of selling.