How do Microsoft’s layoffs affect its stock market outlook? (NASDAQ: MSFT)


Summary in seconds

I have a buy investment rating for Microsoft Corporation (NASDAQ: MSFT) shares.

I assessed the five-year or mid-term outlook for MSFT with my previous write-up on September 6, 2022. I turn my attention to Microsoft’s recent layoffs with this current update.

MSFT reportedly recently laid off some of its employees, which is in line with company guidelines to maintain short-term workforce stability. Given the company’s expense management initiatives such as those related to staffing, Microsoft is forecasting a “double-digit” increase in operating profit for fiscal year 2023 (YE June 30). Despite management’s reasonably good guidance for the current fiscal year, MSFT’s EV/EBIT and P/E valuation multiples are now close to their respective three-year all-time lows. As such, I deem Microsoft’s stock to be undervalued and am assigning a buy rating to the stock.

How many workers is Microsoft laying off?

Microsoft released the company’s financial results for the first quarter of fiscal 2023 last week (October 25), and management’s comments during MSFT’s recent quarterly earnings call on the same day caught the attention of investors on his layoffs.

In its first quarter fiscal 2023 investor briefing, MSFT indicated that “our sequential headcount growth from the first quarter (fiscal 2023) through the second quarter (fiscal 2023) will be minimal.” In other words, Microsoft’s guidelines imply that there will be no significant increase in the number of company employees between September 30, 2022 and December 31, 2022.

Earlier, on October 18, 2022, Looking for new Alphas article quoted a the wall street journal report which mentions that Microsoft “laid off nearly 1,000 employees in several divisions”.

Key measures of MSFT actions

There are a few metrics investors should watch with regards to Microsoft’s recent layoffs and its goal to keep its workforce stable on a quarterly basis for the second quarter of fiscal 2023.

The company only reveals its official number of employees once a year with its 10-K documents. MSFT previously disclosed in its 10-K filing for fiscal year 2022 that it “employed approximately 221,000 people” at the end of the first half of this year. This suggests that Microsoft is laying off around 0.5% of its workforce.

Notably, the total number of Microsoft employees increased significantly +22% in fiscal year 2022 compared to its workforce of 181,000 at the end of fiscal year 2021. The substantial increase in the workforce of MSFT 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 staff also coincided with an increase in operating costs. Specifically, Microsoft’s research and development, sales and marketing, and general and administrative expenses increased by +18%, +8%, and +16%, respectively, for fiscal year 2022.

Why is Microsoft laying off employees?

The key MSFT indicators highlighted in the previous section help to understand why Microsoft is laying off employees. The number of employees and the company’s operating expenses are increasing, which is not favorable given the difficult economic context.

Microsoft stressed during its first-quarter fiscal 2023 earnings briefing that the company’s goal is “to use this (additional) headcount in the most productive way possible.” More importantly, MSFT emphasized on the last quarterly earnings call that it “will be disciplined in managing our cost structure” to “respond to the macro.”

The company’s efforts to slow the pace of recruitment have already paid off to some extent in the first quarter of the current fiscal year. As reported in its latest quarterly earnings presentation, Microsoft’s actual operating costs for the first quarter of fiscal 2023 were $13.2 billion and were lower than its previous management forecast in the range of $13.3 to $13.4 billion. This is a key factor contributing to MSFT’s +2% earnings growth in the first quarter of FY2023.

What is Microsoft’s business outlook now?

Along with announcing its financial results for the first quarter of fiscal year 2023, Microsoft offered its guidance for fiscal year 2023.

According to its press release and outlook presentation, Microsoft expects the rate of increase in its operating costs to “moderate materially throughout the year (fiscal 2023)”, which should result in by a 1% decline in its FY2023 operating profit margin. MSFT attributed expectations of a slower pace of operating expense growth for the year to “the company’s focus on productivity growth from the significant investments in the workforce that we have made over the past year” during its first quarter fiscal 2023 earnings call.

It should be noted that MSFT’s guidance indicates “double-digit revenue and operating income growth at constant currency” for the company in fiscal 2023, consistent with management’s comments during the recent quarterly results briefing.

I think it’s encouraging to see Microsoft strike a good balance between maintaining short-term profitability and investing to drive long-term growth.

Microsoft’s expected “double-digit” increase (I’m guessing it’ll be in the lower teen percentage range) in FY2023 operating profit is very likely to be lower than actual growth in the operating profit of +21% in constant currency for the company in fiscal 2022, but operating profit growth above +10% will still be quite good in this difficult economic environment.

It is reasonable to assume that MSFT could have guided much stronger FY2023 operating income growth, had it chosen to reduce capital expenditures and further reduce its workforce. As I mentioned earlier in this article, Microsoft has reportedly laid off about 0.5% of its employees and is only aiming for a stable workforce (rather than a substantial reduction) in the future.

This particular Q&A on the company’s first quarter investor call sends a clear signal that Microsoft won’t sacrifice long-term growth to maintain near-term profitability at all costs. An analyst from UBS (UBS) questioned why Microsoft “chose not to cut OPEX (opex)” despite “weakness on the Windows side.” In response, Microsoft Chief Financial Officer Amy Hood replied that “it’s important to stay consistent in this down market” and to “continue to invest where we see substantial opportunity and growth”.

In a nutshell, I have a favorable view of Microsoft’s business prospects. In the short term, MSFT has made layoffs and slowed the pace of new hires in order to control costs and maintain a good level of profitability. But MSFT’s medium to long-term prospects are not affected, as the company does not withdraw its investments in areas that have good long-term growth potential.

Is the 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 forecast for operating profit growth, and its valuations are attractive.

MSFT’s current valuation multiples are approaching three-year all-time lows. The market now values ​​Microsoft at a normalized P/E multiple for the next twelve months of 23.1 times according to the consensus. S&P Capital IQ data, which is only +4% higher than its historic three-year P/E ratio of 22.2x. Similarly, MSFT’s current consensus on the next twelve months EV/EBIT measure of 18.4x is only +3% above its three-year low of 17.8x EV/EBIT.

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