Microsoft 2Q26 Earnings Update: Passing with Flying Colours

Microsoft reported 2Q26 (4QFY26) earnings with a strong beat on both the top and bottom lines, with revenue growing 18% y/y (vs. estimates of 15% y/y), while non-GAAP earnings rose 23% (vs. estimates of 10%), driven by strong cloud and AI momentum. Most importantly, Azure and AI-related cloud metrics exceeded expectations.

The company reported its earnings following Alphabet’s results, which disappointed investors due to another revision to its capital expenditure outlook. Microsoft, continued to increase CAPEX, but unlike Alphabet, did not raise its full-year CAPEX guidance. As such, the shares rose 7% following the earnings release.

Microsoft’s AI bet pays off: Azure steals the show

The headline number was not the revenue beat itself, but where the growth came from. Microsoft’s Intelligent Cloud segment, which includes Azure, posted $39.31 billion in revenue, up 31.6% y/y, while Azure growth accelerated to 43%, compared with 40% in the previous quarter. This exceeded both market expectations and our previous estimate of 40%. Intelligent Cloud’s operating margin also rebounded to 41% from 40% in the previous quarter

We believe that one of the key reasons was operational efficiency. Over the last fiscal year, the company has reduced dock-to-live times for new GPUs in its largest regions by nearly 50%. The company added another gigawatt of capacity this quarter and remains on track to roughly double overall capacity in just two years.

The acceleration pushed full-year Azure revenue past $100 billion for the first time in the company’s history, a milestone that Chief Executive Satya Nadella was quick to highlight. At this scale, Azure remains the second-largest public cloud platform by revenue behind  Amazon Web Services (AWS) among the major cloud providers and remaining larger than Google Cloud.

Future growth also remains encouraging, with commercial remaining performance obligations (RPO) — essentially the backlog of contracted but not-yet-recognised revenue — surging 84% y/y to $678 billion, up 8% q/q. This figure points to a substantial pipeline of committed customer spending stretching well into the future.

Microsoft also reported continued traction for its AI assistant. The company said Microsoft 365 Copilot surpassed 30 million paid seats during the quarter (vs. 20 million in 1Q26), up sharply from a year earlier. Hundreds of enterprise customers have purchased millions of seats for its high-end E7 productivity software bundles. See More details.

This was somewhat unexpected given Microsoft’s previously decision to retire its Copilot Podcasts and Copilot Labs features on 18 August 2026. We believe this could indicate that some of these features were less well received by users than expected. However, the strong growth in paid seats helps alleviate concerns regarding user adoption and monetisation. In addition, GitHub Copilot now has 50 million users. This is a positive sign that enterprises are increasingly moving from pilot programmes to paid deployments.

More details: The number of conversations per user nearly doubled y/y. Average weekly engagement is on par with Outlook and Teams. The time from deployment to high usage (meaning monthly active usage) has fallen from months to just days over the past year. The number of customers with more than 50,000 seats increased over 7x y/y, and the number of enterprise customers deploying Copilot to the majority of their information workers grew nearly 75% q/q, a signal of how central Copilot has become to their operations.

Moving forward, we have revised our forecast for Azure cloud growth to be 43% for the next quarter, with operating margins for the Intelligent cloud segment to stay above 40%.

Figure 1: Azure Cloud growth accelerated; Margins improved

Moderate performance across other segments

Productivity and Business Processes — the segment that houses Microsoft 365, LinkedIn and Dynamics — grew 14%.

More Personal Computing, the division tied to Windows, devices, gaming and search advertising, was the laggard. Revenue declined 4% to $12.9 billion. Windows OEM and Devices revenue fell 7%, while Xbox content and services revenue dropped 10%, partly offset by a 10% rise in search advertising revenue, excluding traffic acquisition costs.

Guidance remains supportive

CFO Amy Hood projected Azure growth of roughly 45% for the next quarter, which was also above expectations of 41%. This signals that management sees no imminent slowdown in cloud demand.

Overall, for the next quarter, the company guided revenue of $89.85 billion to $90.95 billion, implying growth of 16% to 17%, with the midpoint above consensus.

Microsoft maintained its full-year CAPEX guidance

Capital expenditure and finance leases reached roughly $41 billion in the quarter alone (vs estimates of $42 billion), representing a 69% increase and the highest quarterly spending ever, as Microsoft raced to build out the data-centre capacity required to support AI workloads.

Most importantly, the company remained its CAPEX forecast for this year (our estimates $175 billion), and did not raise its CAPEX expectations despite stronger cloud growth – This stands in contrast to Alphabet which was well received by investors, although Microsoft mentioned that it expects further growth in 2027.

The elevated spending is reshaping Microsoft’s financial profile. Operating cash flow for the quarter was a robust $55.4 billion, up from $42.6 billion, but the higher capex intensity drew down the company’s cash cushion. Cash and short-term investments fell to $76.8 billion from $94.6 billion a year ago, even as Microsoft returned $10.2 billion to shareholders through dividends and buybacks, broadly similar to the previous quarter.

The CFO also flagged an accounting change that will soften the near-term earnings impact of all that construction: Microsoft is extending the assumed useful life of its office and data-centre buildings to 25 years from 15 years. The change lowers annual depreciation expense, which supports reported margins.

While this could attract some scrutiny from investors, the company also stated that future data-centre leases will be classified as operating leases rather than finance leases. This is a more conservative accounting approach, as it will reduce the company’s EBITDA and operating cash flow.*

*Investors should note that this treatment may reduce the visibility of total infrastructure investment when comparing reported CAPEX across periods.

Another important point to highlight is that the company mentioned that free cash flow (FCF), which declined to $19.6 billion this quarter, is expected to remain positive in fiscal 2027. With Alphabet and Oracle having already turned FCF negative, this should provide reassurance to investors concerned about cash generation.

Figure 2: Microsoft CAPEX and Finance Leases expected to increase

Table 1: Impact to balance sheet due to the reclassification

Financial Metric	Finance Lease	Operating Lease
Net Income (Early Years)	Lower (Front-loaded interest + straight-line depreciation)	Higher (Straight-line single lease expense)
EBITDA & EBIT	Higher (Lease payments are pushed below the line into D&A and Interest)	Lower (Total rent is deducted as an operating expense)
Operating Cash Flow (OCF)	Higher (Principal repayments are reclassified to Financing Cash Flows)	Lower (Entire lease payment hits OCF)
Balance Sheet Leverage	High	High

Reiterating BUY on Microsoft

Overall, Microsoft delivered a strong quarter, with a beat across most segments, strengthening the company’s position in enterprise AI. We believe that the current setup for Microsoft is encouraging, with strong growth in its own AI model and continued execution across cloud infrastructure, AI platforms and enterprise software. Good progress on the entire stack could create a healthier and more sustainable long-term trajectory for the company.

A key concentration risk remains Microsoft's exposure to OpenAI-, which contributes close to 45% of the company’s total RPO, highlighting the company's reliance on a small number of hyperscale AI customers. While demand remains robust, customer concentration should continue to be monitored.

Nevertheless, our positive view on Microsoft remains intact. Once again, supply, rather than demand, remains the binding constraint, reinforcing the durability of underlying AI demand.

We forecast forward earnings for FY27 to grow by 16%, followed by 18% for FY28. Applying our fair P/E of 25x, justified by sustained double-digit earnings growth and structural AI exposure, it implies an upside potential of 34%.

As such, we reiterate a BUY rating on Microsoft with a higher target price of USD 571 by 2028.

	2025	2026	2027Y	2028Y
P/E	36.4	24.6	21.8	18.6
Earnings	13.63	17.28	19.49	22.82
Earnings Growth	15.80%	39.80%	13%	17%
Sales (bil USD)	282	332	386	455
Sales Growth	14.90%	17.80%	16.20%	18.10%
Fair PE				25
Target Price	425.21			571
Upside Potential				34%
Source: Bloomberg Finance L.P., iFAST compilations. Data as of 30 July 2026.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) holds a NIL position in the abovementioned securities. The analyst who produced this report holds a position in the abovementioned securities.

This research report was prepared with the assistance of artificial intelligence (AI) tools. iFAST Financial Pte Ltd does not rely exclusively on AI for content generation; the content of this report – including all investment theses, ratings, price targets and conclusions – has been independently reviewed and verified by the research analyst(s) to ensure accuracy and professional integrity.