Microsoft beats back King Dollar and rising interest rates

Effects from the Federal Reserve's interest rate policy are starting to accelerate.

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This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Despite issues, big tech stocks are incredibly resilient investments. With the global economy up against inflation, the war in Ukraine, and a possible recession in 2023, many tech and software stocks keep chugging higher. Microsoft's (NASDAQ: MSFT) fiscal 2023 first-quarter earnings showcase this resiliency.

But pressure is mounting. A record run-up in the US dollar is only just beginning to blast corporate earnings. Microsoft is going to be more than fine, but a big speed bump looms large. 

King Dollar demands a cut

Just like the other cloud computing giants that reported earnings (Amazon (NASDAQ: AMZN) Web Services and Alphabet's (NASDAQ: GOOGL)(NASDAQ: GOOG) Google Cloud), Microsoft reported a stunning negative effect from currency exchange rates. During the first quarter of its fiscal 2023 (the three months ended 30 September 2022), total revenue increased 11% year over year to $50.1 billion.

However, blacking out the effects of currency exchange rates, revenue would have increased 16%. So, King Dollar took a hefty five-percentage-point toll.  

This is a challenge for any US multinational organization right now. Here's how it works: A sale is made outside of the US and collected in that country's currency, but that money received needs to be converted back into US dollars for reporting purposes. So far, no big deal. But what happens when the dollar increases in value against that foreign currency? Suddenly the value of that international sale gets reduced when exchanged for a stronger dollar. 

All of this is a nasty side effect of the US Federal Reserve's aggressive interest rate hikes this year. Other central banks have been slower to raise rates in their fight against inflation compared to the Fed's record-breaking pace of hikes. This has caused the US dollar's double-digit percentage spike in value this year.  

Thus, Microsoft and friends' problem right now. Revenue growth is still intact, but currency exchange rates are lowering reported financial figures by a very large amount.

A growth stock for nearly 40 years and still counting

The dollar's record run-up is even more demanding on profit margins. Again, like other tech titans, the majority of Microsoft's expenses are made in US dollars. So when those expenses are being made in a strengthening currency versus revenue collected in a weakening international one, the effect is an even larger reduction in profitability. While the dollar took a five-percentage-point cut from Microsoft revenue last quarter, it took a whopping nine-percentage-point cut from operating income -- lowering year-over-year operating profit growth to 6% (versus 15% growth excluding exchange rate effects). Ouch!  

The good news, though, is that even after nearly four decades as a publicly traded company, Microsoft is still very much a growth stock. As CEO Satya Nadella said in the earnings report, "In a world facing increasing headwinds, digital technology is the ultimate tailwind." When software is done right (paired with sticky hardware products we can't separate our lives from), it becomes an incredible growth investment for many decades. With inflation and economic uncertainty the story of the year, Microsoft is still helping its users "do more with less" in new ways.  

Of course, these currency headwinds are expected to continue into Microsoft's Q2 2023 and will likely continue for the rest of the fiscal year. Additionally, the accelerating global economic slowdown is also impacting Microsoft's currency-exchange-neutral growth. The cloud segment Azure, the primary driver of results these days, is projected to slow from a 42% year-over-year growth rate (excluding exchange rates) to about 37% (also currency-neutral) in Q2 fiscal 2023.

While these various factors are concerning, it's clear Microsoft is far more resilient than the average mega-corporation. Shares trade for 24 times trailing-12-month earnings per share (EPS) which looks like fair value to me, assuming the company can grow earnings per share at an average high-single-digit to low-teens percentage for the rest of the 2020s. After all, at some point, the dollar's strength will dissipate -- maybe even reverse -- which would be a boost to Microsoft's revenue and profits.

This market will continue to be wild, but Microsoft looks like a good safe-haven stock to hold for the long term.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Nicholas Rossolillo and his clients have positions in Alphabet (C shares) and Amazon. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Amazon, and Microsoft. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Alphabet (A shares), Alphabet (C shares), Amazon, and Microsoft. The Motley Fool Australia has recommended Alphabet (A shares), Alphabet (C shares), and Amazon. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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