Unjustified Valuation And Repetitive Losses

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Salesforce managed to beat analyst expectations regarding its latest-quarter sales, and generated 37% YOY growth.

Excessive increases in expenses overshadowed the rise in revenues, so earnings failed to reflect the impressive revenue increase.

Salesforce has a robust cash flow position that allows it to continue spending on R&D, sales and marketing.

Salesforce's valuation is trading at an excessive valuation, which provides an opportunity for investors to generate some profits from the stock. Inc. (NYSE:CRM) reported its results for the first quarter of FY2015, and they were marginally ahead of analyst expectations. Despite the fact that the company's losses widened due to an increase in expenses in line with the rise in revenues, the company improved its guidance for the rest of fiscal year 2015. However, it is worth considering whether or not it is a viable investment given its excessively high valuation. This article will try to consider all of these matters to come up with a justified conclusion for investors.

Top and Bottom Lines

Salesforce reported revenues of $1.23 billion in the recent quarter that reflected a decent growth of 37% year-over-year. The company generates its revenues from two segments: Subscription and Support and Professional Services & Other. The following graph illustrates their respective contribution to the company's revenues and cost of sales. The Subscription and Support division is the major contributor of the company's top line, and reported a year-over-year increase in revenues of 36%, while the Professional Services & Other division generated 58% more revenues during this quarter.

Source: Company Press Release

Despite the impressive rise in revenues, the company reported a rise in losses year-over-year. During the first quarter of FY2014, Salesforce ended up with a GAAP loss of $96.9 million, up from $67.7 million in the same quarter last year. GAAP EPS stood at a 16 cents loss per share, while adjusted EPS stood at 11 cents per share, up from 10 cents earned in the same period a year earlier. The reason behind the increased losses is the excessive spending of the company in terms of R&D, sales and marketing. The company's cost of revenues increased by 40%, while its total operating expenses increased by 34%, which was enough to negate the increased revenues during the quarter.

Source: Company Press Release

Financial Position

The following chart provides an overview of the company's income statement in the five previous quarters. As depicted in the graph below, the company's current net profit margin is below the margin in the same period a year earlier, but in the last 3 consecutive quarters, the margin has been improving slightly and gradually. Still, it has to improve very much before it can get back to the level it was during the second quarter of FY 2014.

Source: Bloomberg

Salesforce generated cash flows from operations of $473 million, reflecting a massive increase of 67% year-over-year. This was partly because of the company's stock-based compensation plan. Due to the company awarding its shares to its employees as compensation, cash was not utilized, while increasing the company's shares outstanding by 4% year-over-year. The company ended the quarter with $1.53 billion in cash, cash equivalents, and marketable securities. The company's free cash flows almost doubled year-over-year to $413 million.

Future Guidance

Salesforce raised its guidance for the second quarter of FY 2015, as well as for FY 2015 as a whole. It anticipates earning non-GAAP diluted EPS of $0.11-$0.12 in the second fiscal quarter and $0.49-$0.51 in the full-year FY 2015. On a GAAP basis, the company will continue to report losses per share. For the company to generate revenues of $5.32 billion, on average, during FY 2015, it needs to raise its revenues by 8% over and above the revenues reported in the first fiscal quarter.

The company raised its guidance for FY2015, but now, it is just in line with the analyst expectations as compiled by Thomson Reuters. Analysts were expecting the company to generate revenues of $5.29 billion, on average, and the company's guidance of sales for the fiscal year averages $5.32 billion. This is greater than analysts' average expectations, but the high estimate of analysts stands at $5.35 billion, which is slightly ahead of the high end of the company's guidance at $5.34 billion.

Final Take

Salesforce is a company with a market capitalization of $32.27 billion and a forward P/E of 75.56. This stock is trading at a huge price-to-sales ratio of 7.37 and a price-to-cash flow of 162.47. Salesforce is continually reporting losses on a GAAP basis, and anticipates doing so in FY 2015 as well. Despite the fact that the company is a pioneer in the cloud software business, it has been facing specialized competition that is pushing the company into a corner. In an attempt to combat the competition, the company is trying to diversify its services, but it will take much time to become established, partially due to the fickle nature of the industry, as well as continuous advancements. Therefore, I am bearish on this stock because of two reasons: repetitive losses and the unjustified or excessive valuation at this point in time. I suggest investors sell this stock at its current lucrative price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.