3 Stocks Growing With the Cloud

The recent decision of the US Department of Defense to stick with Microsoft for the money-spinning US$10 billion (£7 billion) JEDI cloud contract underscores the colossal opportunity 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.

With the adoption of cloud services gaining momentum, the following players with moaty characteristics are well-positioned to reap rich rewards:

Search engine Google and video service YouTube’s parent company, Alphabet (GOOG) boasts multiple revenue streams generated from a host of products and services. Apart from Google, which generates 99% 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) and Waymo (self-driving cars) among others.

Alphabet has been pushing aggressively to gain a stronger foothold in the fast-growing public cloud market and is expected to “continue to gain traction in the cloud market,” says Morningstar equity analyst Ali Mogharabi. He adds: "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."

When combined with non-ad YouTube, Google Play, and sales of Google’s hardware products, Alphabet’s other revenue could be growing 34% to US$35 billion (£26 billion) in 2020. Indeed Mogharabi recently raised the stock’s fair value from US$1,520 (£1165) to US$1,690 (£1296), prompted by strong Q2 performances by YouTube, Google Drive, and Google Play, which helped offset a decline in search ad revenue due to Covid-19.

A pure-play cloud computing juggernaut, Salesforce.com (CRM) provides four different cloud solutions: Sales Cloud, Service Cloud, Marketing and Commerce Cloud, Salesforce Platform and Other. Salesforce is generally considered a leader in each.

The wide-moat firm remains the clear leader in salesforce automation (Sales Cloud), where the company has gone from no product to a 33% market share over the last 20 years. 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.

The company will benefit further from cross-selling among its clouds, upselling more robust features within product lines, pricing actions, and international growth. “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 from US$202 (£155) to US$253 (£194), prompted by strong Q2 results.

Silicon Valley tech major, Microsoft (MSFT) develops and licenses 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.

Microsoft’s flagship cloud computing business, Azure, is the crown jewel of the company and is already an approximately US$7 billion (£5.4 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 (£175).