Goldman Sachs: Microsoft Azure growth rises to 48% as cloud gross margin recovers but cash flow comes under pressure

How much did Azure’s guidance beat lift results?

Microsoft’s Azure revenue grew 48% year over year at constant currency in the first quarter of fiscal 2027, above the company’s guidance of 44%–45% and faster than 42% in the prior quarter; market consensus was 45%.
Total revenue for the quarter was 92.279 billion dollars, up 19% year over year and 2% above market consensus. Adjusted earnings per share were 4.89 dollars, above market expectations of 4.73 dollars.
Cloud gross margin recovered to 66% from 65% in the prior quarter. Goldman Sachs believes Azure growth, accelerating commercial cloud growth and improving cloud gross margin together drove the roughly 4% after-hours gain following the earnings report.

Excluding the comparable effect of revenue recognized in the corresponding period a year earlier, Microsoft 365 commercial cloud grew 19% at constant currency, versus 16% in the prior quarter; on a reported basis, growth rose from 15% to 18%.
Growth came mainly from customers upgrading to premium products such as Copilot, E5 and E7, raising average revenue per user; usage-based revenue from GitHub Copilot also increased.
Not all cloud products accelerated: Microsoft 365 consumer cloud grew 16% at constant currency, below 22% in the prior quarter. Commercial bookings fell 11% year over year, against a comparable period in which they grew 111%; commercial remaining performance obligations rose 73% year over year, below 84% in the prior quarter.

Adjusted operating income was 45.915 billion dollars, up 21% year over year; adjusted operating margin was 50%, above market expectations of 49%.
Capital expenditure, including finance leases, was 45.2 billion dollars, up 30% year over year but below market expectations of approximately 51.685 billion dollars. The share of short-lived assets in capital expenditure rose from about two-thirds to about three-quarters.
Free cash flow excluding finance leases was 18.633 billion dollars, down 27% year over year; although above market expectations of 8.537 billion dollars, it was below Goldman Sachs’ estimate of 20.429 billion dollars.

Goldman Sachs is watching the timing and magnitude of Azure growth in fiscal 2027, the allocation of first-party and third-party computing capacity, and the change in new data-center capacity in 2027 compared with 2026.
Whether the in-house Maia chip can scale up significantly and its effect on Azure gross margin are another area of focus for the bank; Goldman Sachs also wants to understand how Microsoft assesses the return on capital from new AI investments.
Goldman Sachs maintained its buy rating and 12-month price target of 640 dollars, with the valuation based on a price-to-earnings multiple of 28 times adjusted net income for the second forward 12-month period. The bank noted that slower scaling of in-house chips could limit market share growth or gross margin expansion.