Azure's Growth Unlimited? Microsoft Deserves the Title of AI Leader

On July 31st, after the U.S. stock market closed, one of the leading AI companies in the U.S. stock market, $Microsoft(MSFT.US), once again delivered an impressive performance, with almost all metrics exceeding expectations. The core Azure growth further accelerated to 39% (at constant currency), even stronger than the generally higher buy-side expectations. Following the earnings release, the stock price surged significantly!

Key points are as follows:

1. Azure once again exceeded expectations with significant acceleration: The most watched and influential single indicator for the company's stock price trend -- Azure's revenue growth rate, this quarter was 39% at both variable and constant currency rates, significantly accelerating by 6 percentage points and 4 percentage points quarter-on-quarter, respectively.

In contrast, at constant currency rates, the company's guidance was for growth to remain flat or slightly decrease by 1 percentage point, and the buy-side only expected a slight acceleration to 36%. Even setting aside the expectation gap, Azure's growth has significantly accelerated for two consecutive quarters, breaking through the growth center that had been hovering just over 30% for a long time. This not only highlights strong demand but also prompts the market to raise subsequent Azure growth expectations.

2. M365 and Copilot continue to make small strides: Another important segment of market focus -- Microsoft 365 commercial cloud services, grew by 16% in revenue at constant currency this quarter, with a slight acceleration of 1 percentage point from the previous quarter.

The driving factors include a 6% year-over-year increase in subscription seat numbers, with a continued slight slowdown as expected. However, due to more users adopting higher-priced E5 and Copilot features, the average customer price increased by about 11% (also benefiting from exchange rate factors).

Overall, the performance of commercial M365 and Office's Copilot is making small strides forward, with no particularly outstanding aspects, still in the stage of increasing user penetration.

3. Overall performance: Total revenue this quarter increased by 18% year-over-year, significantly accelerating from 13% in the previous quarter. Although there was indeed a benefit from the depreciation of the U.S. dollar this quarter, excluding the impact of exchange rates, total revenue growth still accelerated by 2 percentage points quarter-on-quarter. All three major segments of the company experienced growth exceeding expectations.

On the profit side, operating profit grew by about 23% year-over-year this quarter, further accelerating from already impressive revenue growth, with operating profit margin expanding by 1.8 percentage points year-over-year. Microsoft has officially confirmed a dual favorable performance cycle of accelerated growth and margin expansion.

4. Leading indicators show strong performance, not just temporary: This quarter, the amount of newly signed enterprise contracts jumped by 37% year-over-year (30% at constant currency), significantly higher than the previous quarter (less than 20%).

Another indicator, the backlog of contracts to be fulfilled also reached a new high of $368 billion, increasing by nearly 37% year-over-year. The net increase for the quarter was $530 billion. Both the year-over-year growth rate and the net increase for the quarter set historical records.

From the leading indicators, it suggests that not only is Microsoft's confirmed performance this quarter impressive, but the current new demand for various enterprise services is also very strong, indicating that the company's performance in the short to medium term is likely to be equally impressive.

5. Technological efficiency: Although operating profit growth is strong, actual spending on costs and expenses this quarter is in line with or slightly exceeds the guidance given by the company last quarter. In other words, the unexpected profit almost entirely comes from stronger revenue growth, rather than unexpected savings in cost control. Specifically, due to massive Capex investments in AI and other businesses, Microsoft's gross margin is indeed under pressure (narrowing by 1 percentage point year-over-year this quarter).

Overall operating expenses grew by 5.8% year-over-year, with growth still at a relatively low level, partially reflecting the role of AI and other technologies in improving efficiency. The main contribution comes from a 11% year-over-year reduction in management expenses.

6. As Google has recently significantly raised its Capex guidance again, the market's expectations for subsequent investments in GPUs and other hardware have also become more optimistic. Microsoft's spending this quarter, including leases, was $24.2 billion, a slight increase of about $2.8 billion from the previous quarter.

Although it is indeed higher than the spending when Microsoft released some lease contracts, i.e., in the first quarter, it is generally in line with the expectations of leading investment banks observed by Dolphin Research. It has not continued to significantly increase spending like Google. The total expenditure for the full fiscal year is $88 billion, which is roughly in line with the previously given budget.

However, on the earnings call the company guided that next quarter’s Capex will be roughly $30 billion, marking yet another significant uptick.

7. Future guidance: In terms of large numbers, the company's guidance for the next quarter's total revenue and operating profit, with implied year-over-year growth rates of 14.7% and 14.9% at the midpoint, both show a significant narrowing compared to this quarter's growth rates, similar to the situation in the previous F3Q25, also implying that the operating profit margin will remain roughly flat.

Moreover, this guidance includes about 2 percentage points of contribution to revenue growth from favorable exchange rates. Therefore, according to this guidance, with more apparent exchange rate benefits, both revenue and profit growth rates are declining quarter-on-quarter, which clearly does not look like good news from a trend perspective.

However, on one hand, the situation of weaker guidance growth and stronger actual performance in the past two quarters has desensitized the market to the management's conservative guidance. On the other hand, compared to market expectations before the earnings release, this guidance still exceeds expectations across the board.

In key businesses, management expects Azure's growth rate at constant currency to be 37%, although the guidance decelerates by 2 percentage points quarter-on-quarter. However, before the earnings release, the market's expectation was also for a deceleration from 36% in F4Q25 to 34% in F1Q26. In other words, the market had already anticipated a seasonal deceleration of 2 percentage points, but the actual guidance's absolute growth rate is still higher than expected.

Dolphin Research's View:

In summary, Microsoft's performance this time is clearly outstanding, with all the indicators in the table above exceeding market expectations. Before the earnings release, the market's main focus on Microsoft's performance was on two points: 1) How is Azure's growth rate, can it further accelerate, and whether supply bottlenecks still exist, 2) How the company offsets the impact on operating profit through Opex adjustments under the pressure of massive Capex spending on gross margin.

Other relatively minor points of focus include: 3) Whether there is a significant improvement in Copilot's penetration and its contribution to driving P&BP segment revenue, 4) How the company's previous large-scale layoffs impact expenses and company profitability, 5) Some changes in the close cooperation relationship between the company and OpenAI (OpenAI migrating some computing needs to Oracle and other platforms), and how much impact this has on Azure.

We can see that Azure's growth has once again exceeded expectations with a significant increase, continuously breaking upwards, indicating that under the leadership of AI and other related demands, the market's demand for cloud computing is very strong, and Azure is undoubtedly the leader and biggest beneficiary among several major providers.

The issue of computing power bottlenecks seems to have at least temporarily been resolved, and OpenAI's migration of some needs does not currently show a significant impact.

Secondly, under the pressure of gross margin, Microsoft has created a large amount of unexpected incremental revenue, while Opex spending has not exceeded the original budget. With only single-digit expense growth, it has ensured that the profit margin not only did not decline but also improved, with operating profit growth returning to over 20%. The effect of layoffs also seems to be reflected in the significant reduction in management expenses.

Therefore, it can be said that this performance has nearly perfectly answered all the market's previous questions. Combined with the significantly rising leading indicators, it presents a prosperous scene.

Combined with the guidance provided by management, looking ahead to the company's performance trend in the short to medium term, as mentioned earlier. Although the company's guidance appears somewhat conservative, the increase in major indicators compared to this quarter will decline. However, after multiple instances of exceeding expectations, the market's skepticism towards the company's caution is no longer as "trusting."

1) On the growth side, although the market indeed needs to use the company's guidance as a benchmark, concerns about tariffs, re-inflation, and the U.S. economic recession that were still high last quarter have largely dissipated. Recent significant advancements in AI models have also brought the enthusiasm and confidence of the real and capital markets for AI back to a high point. In the absence of black swan macro events, it is currently difficult to see factors that would cause Microsoft's performance trend to decline. Even if it does weaken slightly compared to this quarter, it is likely to remain at a relatively high level of prosperity.

2) On the profit margin side, as the company expects Capex in fiscal year 26 to continue growing compared to this fiscal year, and structurally, the proportion of short-lifecycle equipment such as GPUs will gradually increase. The current market consensus is that depreciation of assets will rapidly climb starting in FY26, and according to predictions from multiple Wall Street firms, it may drag down operating profit margins by 2~3 percentage points in the coming years.

In response, Microsoft needs to hedge through optimizing product structure and controlling operating expenses. However, through this performance and the large-scale layoffs totaling about 16,000 people in the past six months, Microsoft seems to have proven its ability to cope with profit margin pressure.

In other words, in the short term, Microsoft's performance and stock price are likely to continue to trend steadily upward.

From a valuation perspective, as shown in the chart below, Microsoft's stock price has fluctuated within a valuation range of approximately 25x~35x forward earnings per share over the past five years. During this period, overall macro sentiment, market optimism about AI stocks, and the trend of Microsoft's performance can all be key factors affecting valuation fluctuations.

Recently, with the decline of macro risks such as tariffs and the market's sentiment towards AI becoming extremely optimistic again, Microsoft's forward valuation multiple has once again reached the high end of the range above 35x. Although from an absolute perspective, the current market's expectations for Microsoft's revenue growth of about 10~15% and profit growth of 15%~20% over the next 2~3 years, corresponding to a forward valuation multiple center of around 30x, inevitably includes a considerable premium.

Whether this valuation and premium are reasonable is a debatable question. Undoubtedly, it includes recognition of Microsoft's competitive barriers and its leadership in AI software, as well as expectations for incremental profits from AI that have not yet been reflected in performance expectations. Whether reasonable or not, the market has already accepted this valuation center, so as long as the AI narrative and Microsoft's performance remain in a good cycle, even if the valuation does not appear cheap, there will still be room for further upward movement.

The above is the summary part of this earnings report commentary, with detailed commentary continuously being updated.

Overview of Changes in Financial Reporting Disclosure Scope

Beginning in FY25, Microsoft implemented substantial adjustments to the departmental structure used in its earnings disclosures. The core of this realignment was to move all enterprise-facing 365 services—including Commercial Office 365, Windows 365, and Security 365—out of their original reporting segments and into the Productivity & Business Processes (PBP) segment. Dolphin Investment Research provided a detailed analysis of this initial FY25 restructuring, so we won’t repeat those details in each subsequent report. The chart below offers a concise summary of these changes. For a more in-depth discussion of the scope adjustments, please refer to our 1Q25 点评.

2. Segment Performance: Is Azure’s Growth Truly Uncapped?

1.1 Azure Growth Once Again Beats Expectations, Setting a New High

The market’s most closely watched business—Azure—expanded by 39% this quarter on both reported‐currency and constant‐currency bases, accelerating by 6 percentage points and 4 percentage points quarter-on-quarter, respectively. That comfortably outpaces Microsoft’s guidance for growth to remain flat or dip by 1 percentage point q-on-q, as well as the buy-side consensus anticipating a modest pick-up to 36%.

The company did not further break out Azure growth between AI and non-AI workloads this quarter. This aligns with management’s view last quarter that there is no clear boundary between AI and non-AI businesses and that they drive cross-demand for one another. The company also stated that this latest strong Azure growth was driven by demand across all workloads.

Overall, thanks to Azure’s stronger-than-expected performance, the Intelligent Cloud segment delivered $29.9 billion in revenue this quarter, up nearly 26% year-over-year and accelerating sequentially by about 25 percentage points. This result significantly outpaced market expectations of roughly 22% growth, aided in part by favorable currency movements.

1.2 Copilot Still Making Incremental Progress

The second-most important sub-segment—Microsoft 365 Commercial Cloud—grew 16% year-over-year in constant currency, accelerating modestly by 1 percentage point from the prior quarter.

Breaking down the volume and price drivers:

1）Paid seats increased by 6% year-over-year this quarter, down slightly from 7% last quarter. However, this deceleration was largely anticipated ahead of the results, given that user penetration is nearing its ceiling.

2）The primary growth catalyst was a roughly 11% year-over-year increase in average revenue per user (ARPU). While favorable FX rates provided a tailwind, wider adoption of higher-priced E5 SKUs and Copilot features played an even more significant role.

Moreover, according to Wall Street estimates, Office Copilot’s paid adoption rate remains modest. Its contribution to annualized revenue has reached only about $0.5–1 billion, so its overall impact on total M365 revenue remains quite limited.

Other sub-segments within the Productivity division also registered a clear acceleration this quarter versus the prior quarter (with foreign-exchange effects contributing roughly 2–3 percentage points of the uplift).

The personal M365 business saw the most pronounced improvement, jumping twofold to 20%. This was largely driven by Microsoft’s first price increase for Personal M365 in 12 years, implemented around January of this year—raising the price from $6.99 to $9.99 (an approximate 40 percent increase).

Overall, buoyed by foreign-exchange tailwinds and the benefit of average price increases on both Commercial M365 and Personal M365, the Productivity & Process segment’s overall revenue growth accelerated to nearly 16% this quarter—well above the Bloomberg consensus of just over 10%.

1.3 Slight Improvement in Consumer Growth

Having fully cycled past the impact of consolidating Activision Blizzard, growth in the Consumer Computing segment has returned to a more normal pace. Revenue rose 9% this quarter, up from 6% in the prior quarter.

By sub-segment, Windows, Search Advertising and Gaming all saw modest acceleration. Search Advertising revenue, net of traffic acquisition costs, increased 21% year-over-year—an appreciable gain. The company explained that both search volume and revenue per search drove this growth.

2. Not Only Outstanding Quarterly Results but Also Robust Leading Indicators

Thanks to Azure’s exceptionally strong growth far exceeding expectations, the other segments—while not quite as dazzling—also outperformed market forecasts. Overall, Microsoft’s revenue for the quarter came in at $76.4 billion, up 18% year-over-year, with clear sequential acceleration. Even after stripping out favorable foreign-exchange impacts, growth still accelerated by about 2 percentage points quarter-over-quarter. This is a marked improvement over last quarter’s guidance, which had cautioned that constant-currency revenue growth might slip slightly.

At the same time, this quarter’s leading indicators were equally impressive:

New Enterprise Contract Signings rose 37% year-over-year (30% in constant currency), a significant jump from under 20% last quarter.

Backlog of Contract Commitments also hit a record $368 billion, up nearly 37% year-over-year, with a quarterly net increase of $53 billion. Both the year-over-year growth rate and the single-quarter net addition set all-time highs.

3. Continued Margin Expansion as Disciplined Cost Management Offsets Heavy Investments

On the profitability front, operating income grew about 23% year-over-year this quarter—outpacing an already strong revenue performance—and operating margins expanded by 1.8 percentage points year-over-year. While gross margin was under pressure from substantial CapEx investments, optimizations in operating expenses successfully offset that headwind.

1）Gross Profit: This quarter’s gross margin was 68.6%, down roughly 1 percentage point year-over-year, reflecting the drag from heavy CapEx. However, with revenues beating expectations by about $2.5 billion, cost of goods sold totaled $24 billion—only slightly above the prior guidance cap of $23.8 billion.

2）Expenses: Combined sales, R&D, and administrative expenses grew just 5.8% year-over-year. Even with revenues far surpassing guidance, actual spending landed exactly at the top end of the prior range. The company did not loosen its budget controls despite stronger growth—administrative expenses alone fell 11% year-over-year and made the largest contribution to expense discipline.

3) By segment, you can see that since fiscal 2025 each segment’s operating profit margin has been continuously declining year-over-year. (On a same-day year-over-year basis, the P&BP and MPC segments’ margins are still improving.) Among them, the decline in the Intelligent Cloud segment is the most pronounced. From this perspective, as the drag from CapEx on margins becomes increasingly apparent, the company’s ability to maintain disciplined cost control will be the decisive factor in whether Microsoft’s operating profit margin in fiscal 2026 expands or contracts.

4. CapEx Was Not Significantly Raised
Because Google earlier again materially raised its CapEx guidance, market expectations for subsequent GPU and other hardware investments have grown more optimistic. This quarter, Microsoft’s CapEx—including lease expenditures—came to $24.2 billion, a modest increase of about $2.8 billion sequentially.

Although this is indeed higher than the spending in Q1 when reports first surfaced that Microsoft was rolling out certain lease agreements, it is broadly in line with the forecasts of the major investment banks Dolphin has tracked. Microsoft did not, as Google did, continue to substantially up-guide its spending. The full-year total of $88.0 billion also aligns closely with the previously issued budget.

It is also worth noting that, although the company had earlier indicated that short-lived equipment assets would account for a larger share of CapEx, this announcement still shows that more than half of CapEx is being invested in long-lived assets.