Barclays: Microsoft Azure and Office accelerate together as faster AI investment also weighs on cash flow

Why did first-quarter results beat expectations?

In the first quarter of fiscal 2027, Microsoft revenue rose 18.8% year over year to 92.279 billion dollars, 1.8% above the market consensus; Agents & Infra grew 24.5%, 1.6% above consensus.
Azure constant-currency revenue grew 48% year over year, accelerating from 42% in the prior quarter and exceeding Barclays’ previous forecast of 45%. Drivers included Foundry, improved GPU efficiency and revenue per token, and better monetization of idle CPU capacity.
Microsoft expects Azure constant-currency revenue growth of 49%–50% in the second fiscal quarter, and says demand continues to exceed available supply; some third-party computing capacity deliveries have been delayed until the second half of the fiscal year.

Microsoft 365 Commercial cloud revenue grew 17% year over year as reported; after adjusting for the impact of revenue recognition in the prior-year period, constant-currency growth was 19%. Copilot revenue growth accelerated sequentially, while higher-priced products such as M365 Copilot, E5 and E7 drove growth in average revenue per user.
Barclays believes the acceleration in Office adds to the channels through which Microsoft can generate growth from AI; the business also has higher gross margins and helps differentiate products. Management expects this growth trend to continue over the next several quarters.
Management also noted that usage-based consumption of M365 Copilot is expanding more slowly than GitHub: customers must first buy seats, and Microsoft’s sales approach and customers’ purchasing habits also need to change accordingly.

Overall operating margin in the first quarter was 49.8%, above the consensus estimate of 48.3%; however, the Agents & Infra segment’s operating margin fell by about 0.3 percentage points year over year to 52.8%, while investment in research and development, computing capacity and talent continued to rise.
Management expects second fiscal-quarter revenue to grow 18%–19% year over year, cost of revenue to rise 26%–27%, and operating margin to decline slightly year over year.
First-quarter free cash flow was 18.6 billion dollars, down 27.4% year over year. The company expects second fiscal-quarter capital expenditure to exceed 50 billion dollars, above the market consensus of 47.1 billion dollars; its calendar 2026 capital expenditure guidance was lowered from about 175 billion dollars to about 170 billion dollars.
The company still expects full-year free cash flow to be positive. Barclays’ model forecasts free cash flow of 43.235 billion dollars in fiscal 2027, down from 66.987 billion dollars in fiscal 2026; capital spending is expected to accelerate in the second half of the fiscal year as the company invests in CPUs, storage, GPUs and delayed third-party capacity.

First-quarter Devices & Consumer revenue fell 3.2% year over year, including a 22% decline in Windows OEM and device revenue. Channel inventory reductions, weak PC demand and a high comparison base from the end of support for Windows 10 last year are creating pressure; the company expects that revenue to decline by about 35% in the second fiscal quarter and then remain at roughly that rate for the rest of the fiscal year.
Barclays maintained its Overweight rating and raised its price target from 600 dollars to 610 dollars; the valuation is based on its raised calendar 2027 earnings-per-share forecast of 21.94 dollars and a price-to-earnings multiple of about 28 times.