3 stocks growing with the cloud
Accelerated adoption of digital cloud-based operations with the pandemic has these companies seeing significant profit potential.
The recent decision of the US Department of Defence to stick with Microsoft for the money-spinning US$10 billion ($13.6 billion) JEDI cloud contract underscores the colossal opportunity that cloud computing represents for service providers.
At a time when the pandemic is accelerating the global transition to cloud-based operations, government and private enterprises are scrambling to digitise and stabilise. Apart from ensuring smooth, seamless, and secure functioning of businesses, a migration to the cloud offers a raft of other benefits including improved speed, simplified innovation, scalability, and lower risk.
And money going into the cloud speaks volumes. Research firm IDC projects investments in cloud IT infrastructure to reach US$69.5 billion, 54.2 per cent of the overall IT infrastructure spend, in 2020. Longer-term, it forecasts this spending to reach US$105.6 billion in 2024, growing 9.6 per cent annually. Further, the worldwide public cloud services market is poised to jump 17 per cent in 2020, clocking US$266.4 billion, up from US$227.8 billion in 2019, according to IT research firm Gartner.
With the adoption of cloud services gaining momentum, the following players with moaty characteristics are well-positioned to reap rich rewards. In a post-pandemic world, these cloud companies could see a significant jump in cloud-driven revenue and profit as more businesses start seeing cloud infrastructure investments as a source of competitive advantage rather than a cost burden.
Alphabet Class C (GOOG)
Price: US$1519.28
Fair Value Estimate: US$1,690
Fair Value Status: Fairly valued
Economic Moat: Wide
Moat Trend: Stable
Star Rating: ★★★
Data as of 15 September 2020
Search engine Google and video service YouTube’s parent company, Alphabet, boasts multiple revenue streams generated from a host of products and services. Apart from Google, which generates 99 per cent of Alphabet revenue, the Internet giant’s other revenue comes from sales of apps and content on Google Play and YouTube, as well as cloud service fees. The company also sells hardware including Chromebooks, the Pixel smartphone, Nest smart devices, and Google Home. The company’s futuristic bets include Verily (technology to enhance health), Google Fiber (home Internet), Waymo (self-driving cars), and others.
The company has been pushing aggressively to gain a stronger foothold in the fast-growing public cloud market. “Google has quickly leveraged the technological expertise it applied to creating and maintaining its private cloud platform to increase its market share in this space, driving additional revenue growth, creating more operating leverage, and expanding its operating margin, which we expect will continue,” says a Morningstar equity report.
Google is set to gain a stronger foothold in the growing enterprise cloud market, and while its cloud offerings don’t create a network effect enjoyed by Amazon.com, the search engine behemoth is expected to “continue to gain traction in the cloud market (35 per cent revenue CAGR through 2024),” says Morningstar equity analyst Ali Mogharabi. When combined with non-advertisement YouTube, Google Play, and sales of Google’s hardware products, Google’s other revenue could be growing 34 per cent to US$35 billion in 2020, adds Mogharabi, who recently raised the stock’s fair value to US$1,690 from US$1,520, prompted by strong second-quarter performances by YouTube, Google Drive, and Google Play, which helped offset a decline in search ad revenue caused by the coronavirus.
Salesforce.com (CRM)
Price: US$246.54
Fair Value Estimate: US$253
Fair Value Status: Fairly valued
Economic Moat: Wide
Moat Trend: Positive
Star Rating: ★★★
Data as of 15 September 2020
A pure-play cloud computing juggernaut, Salesforce.com provides enterprise cloud solutions, including Sales Cloud, the company’s main customer relationship management software-as-a-service product. The company currently offers four different clouds: Sales Cloud, Service Cloud, Marketing and Commerce Cloud, and Salesforce Platform and Other. Salesforce is generally considered a leader in each.
The wide-moat firm remains the clear leader in sales-force automation (Sales Cloud), where the company has gone from no product to a 33 per cent market share over the past 20 years. “Salesforce.com’s critical differentiator was that the software was accessed through a web browser and delivered over the Internet, thus inventing the SaaS software delivery model,” says a Morningstar equity report.
The segment enjoys the widest moat as a stand-alone product among all of Salesforce.com’s cloud solutions. “A variety of industry data points clearly indicate the Sales Cloud SFA solution is a best-of-breed solution, which by itself creates a certain amount of organizational inertia, as IT managers and executives engage in self-serving behaviour,” says Morningstar equity analyst, Dan Romanoff.
Salesforce’s customer support cloud (Service Cloud) and marketing automation solutions cloud (Marketing Cloud) offer solutions that “encompass nearly all aspects of customer acquisition and retention and are mission critical,” he adds.
The company will benefit further from cross-selling among its clouds, upselling more robust features within product lines, pricing actions, and international growth. “Salesforce is widely considered a leader in each of its served markets, which is attractive on its own, but the tight integration among the solutions and the natural fit they have with one another makes for a powerful value proposition,” says Romanoff, who recently upped the stock’s fair value to US$253 from US$202, prompted by strong second-quarter results.
Microsoft (MSFT)
Price: US$205.41
Fair Value Estimate: US$228
Fair Value Status: Fairly valued
Economic Moat: Wide
Moat Trend: Stable
Star Rating: ★★★
Data as of 15 September 2020
Silicon Valley tech major Microsoft develops and licenses consumer and enterprise software. Known for its Windows operating systems and Office productivity suite, the company operates three segments: productivity and business processes (legacy Microsoft Office, cloud-based Office 365, SharePoint, Skype, LinkedIn), intelligence cloud (infrastructure- and platform-as-a-service offerings Azure, Windows Server OS), and more personal computing (Windows Client, Xbox, Bing search, Surface computing devices). Through acquisitions, Microsoft owns Xamarin, LinkedIn, and GitHub.
Since CEO Satya Nadella took the helm, the company has reinvented itself as a cloud leader. “Microsoft has become one of two public cloud providers that can deliver a wide variety of PaaS/IaaS solutions at scale,” says a Morningstar equity report. One of its more high-profile cloud deals came when Microsoft landed a US$10 billion JEDI cloud-computing contract awarded by the Defence Department to help the Pentagon modernize its colossal IT infrastructure.
Microsoft’s flagship cloud computing business, Azure, is the crown jewel of the company and is already an approximately US$7 billion business. “Azure has several distinct advantages, including that it offers customers a painless way to experiment and move select workloads to the cloud,” says a Morningstar equity report, adding that the company “is also shifting its traditional on-premises products to become cloud-based SaaS solutions.”
Notably, the tech giant’s Office 365 retains its virtual monopoly in office productivity software. “We believe that customers will continue to drive the transition from on-premises to cloud solutions, and revenue growth will remain robust with margins continuing to improve for the next several years,” says Romanoff, who puts the stock’s fair value at US$228.
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