Microsoft 3Q26 Earnings Update: AI investment starting to pay off; Maintain BUY

Microsoft started its 2027 fiscal year with a quarter that comfortably beat estimates across both the top and bottom lines. Capital expenditure fell short of investors’ expectation, easing immediate cash-flow concerns.

For the first time, Microsoft reported Azure's quarterly revenue in actual dollars, providing greater visibility into the scale of the business. Shares rose approximately 4% in after-hours trading to around $550.

From unnoticed to an overnight sensation

For the three months to 30 September 2026, revenue rose 19% to $92.28 billion, beating the roughly $90.65 billion expected by analysts. Adjusted earnings came in at $4.89 per share against a $4.72 consensus, and on a GAAP basis, the company earned $4.92, up 32% from a year earlier. Net income reached $36.63 billion.

Notes. Actuals from Microsoft's FY27 Q1 press release (quarter ended September 30, 2026; reported October 28, 2026). Consensus reflects Street estimates (Benzinga/LSEG: revenue ~$90.65B, non-GAAP EPS ~$4.72); Microsoft does not publish per-line guidance, so "—" marks metrics with no cleanly published line-item consensus. Non-GAAP figures exclude the impact of investments in OpenAI (a $207M / $0.03 net gain this quarter). FY27 reporting segments changed in September 2026 — prior-year segment figures are recast; old Intelligent Cloud / P&BP / MPC series end with Q4 FY26. Capex shown is cash additions to P&E; the >$50B guide was on a finance-lease-inclusive basis, so the two are not directly comparable. "cc" = constant currency. For internal research use — verify against the 10-Q before publication.

Azure growth accelerates again

For the first time, Microsoft reported Azure's revenue in actual dollars—$33.17 billion for the quarter—and stated the business grew by 48% year-on-year. This surpassed both management’s guidance and the upper bound of estimates, which sat at 45% growth.

At this level, Azure is generating approximately $11 billion more quarterly revenue than a year earlier—a pace of absolute dollar growth that few businesses of any kind can match. Microsoft’s Azure faced considerable backlash months ago when the company allocated computing resources to grow in-house models, which affected Azure’s growth. However, this quarter suggests that earlier resource-allocation concerns have not prevented Azure from accelerating. Microsoft guided for even faster expansion ahead, projecting Azure growth of 49% to 50% for the December quarter. Overall Microsoft Cloud revenue reached $63.9 billion, an increase of 30%, which also exceeded expectations.

The strong growth was attributed to the ability to bring capacity online faster. The company added 24 new data centres across five continents this quarter, and reduced the time from equipment delivery to deployment by about 20% quarter over quarter for new GB300s. Microsoft stated that its in-house Maia 200 chips are already delivering up to 1.7 times more tokens per watt across AI experiences in Teams and Copilot. And the company expects Maia 300 to drive further gains, delivering 40% more tokens per watt compared to leading GPU-based systems. Beyond GPUs, the company continue to see strong adoption of their cloud-native Cobalt CPUs, improving price-performance for general-purpose cloud workloads.

On the other hand, a minor blemish was Microsoft's commercial remaining performance obligations—contracted revenue it has booked but not yet recognised. This rose 73% year-on-year to $677 billion, marking a slight decline from the previous quarter’s $678 billion. RPO has a weighted average duration of 2.3 years and roughly 30% is expected to be recognised as revenue over the next 12 months. This near-term portion increased 29% year-over-year while the portion recognised beyond the next 12 months increased 98%.

We do not interpret the slight sequential decline alone as evidence of weaker AI demand, as individual large contracts can materially affect the aggregate. However, the timing and concentration of backlog conversion remain important to monitor.

Microsoft also reported a 50% increase in users of its Microsoft 365 Copilot AI assistant, though it did not disclose the number of paid seats. The overall operating margin for the Agents and Infrastructure segment was 52.8% (incomparable due to it being a newly formed segment).

 Figure 1: Microsoft’s Azure growth gaining momentum 

Figure 2: RPO slowing QoQ

Other segments were a drag, but not enough to dampen investors' optimism

Sales of devices and Windows licences declined by 22%, as higher memory and storage costs elevated prices. The company pointed to weak PC demand and the end of support for Windows 10 last year.

Capital expenditure: Below expectations

Capital expenditure came in at approximately $39.4 billion, falling short of management's $50 billion guidance for the quarter and Street estimates of $51 billion. On the surface, a lighter capex bill eases pressure on cash. Free cash flow—though still down 27% year-on-year to $18.63 billion—was better than the estimated $8 billion, largely thanks to this lower-than-expected capex. Microsoft also returned $10.2 billion to shareholders through dividends and share buybacks for the quarter, a figure broadly in line with the previous quarter.

This lower-than-expected capital expenditure could be attributed to an accounting change announced in the previous quarter (reclassifying leases from finance to operating leases). This is evidenced by operating-lease right-of-use assets jumping to $30.2 billion from $24.2 billion as of 30 June—an addition of about $6 billion in the quarter—with long-term operating-lease liabilities rising by a similar $5.2 billion.

Nonetheless, Microsoft made it clear that it remains capacity-constrained. The company noted that it disclosed Azure's revenue even as it worked through delays from third-party providers with the data centre shells, power, and equipment it relies on outside parties to deliver. The company attributed delays to some third-party capacity deliveries. In other words, the company would have spent more had it been able to. The gap between guided and actual capex reflects a supply chain struggling to build fast enough, rather than a strategic decision to pull back. This is a risk we have highlighted Data Centre Infrastructure 2026: Where are we now, and Where are we heading to: data centre build-out delays are a growing constraint that can delay backlog conversion and cap near-term revenue.

With that, 2026 spend was cut to roughly $170 billion due to the 3P (GPU-as-a-service (i.e. leased GPU capacity from third parties / neoclouds)) capacity delays noted earlier from our previous estimates of $190 billion, with second-half capex expected to accelerate as the 3P capacity deliveries that shifted to 2H land.

In short, Microsoft spent less than expected, but our take is that this is due to capacity and reclassification issues rather than a slowdown in future demand. Microsoft has stated that it expects to remain free-cash-flow positive through fiscal 2027. However, this trajectory depends on two variables moving in its favour: capacity coming online on schedule, and the contracted backlog converting to recognised revenue fast enough to outpace the depreciation that all this new infrastructure will shortly begin to carry.

Figure 3: Capital Expenditure guidance decreases for 2026

Guidance remains optimistic

Forward guidance leaned optimistic. Beyond the 49%-50% Azure growth projection for the December quarter, Microsoft projected next quarter's revenue to be between $96 billion and $97.1 billion. This equates to 18.8% growth at the midpoint, with the lower end of the range exceeding the consensus estimate of $95.60 billion.

Maintain BUY with higher TP

Microsoft is converting an extraordinary cash engine into physical AI capacity on the conviction that the revenue will arrive to fill it. The results so far support this thesis: growth is accelerating, the backlog is enormous, and margins are stabilising.

Capacity constraints remain a near-term risk to Azure’s growth, while the broader investment risk is whether incremental revenue converts into durable earnings and cash flow. Nonetheless, we view management's guidance of 50% growth for the next quarter as achievable.

As such, we have revised our target price (TP) upwards to $625 to reflect higher earnings forecasts. However, as the share price has increased by close to 30% since our last update, there is now less room for a valuation re-rating. Further share-price gains will need to be supported primarily by earnings delivery.

We maintain a BUY rating with lower upside potential of 19.6%.