Salesforce.com: Management Expects Strong Growth, But Its Stock Is Expensive

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About: salesforce.com, inc. (CRM)
by: Kurt Pollet
Summary

Salesforce.com has expanded significantly over the last decade, with an average growth rate of 78% per year.

Management expects 20% per year growth going forward.

Salesforce.com derives its growth from a combination of organic growth and acquisitions.

Salesforce.com is a fast growing company, but I think its stock is too expensive to buy at current prices, so I'm on the sidelines.

Financials

Salesforce.com, Inc. (CRM) has produced strong growth over the last decade and management is expecting more growth for 2021. The company operates with moderate profit margins and returns on equity. While the company's profit margin was reasonable at 8% for the last fiscal year, the margins have been poor over the last decade. Also, the return on equity is currently at 8%, but this is the best it's been for the last decade.

The company's balance sheet shows moderate debt levels with Salesforce.com's long-term debt at only 10% of the value of its assets and its total liabilities is 49% of the value of its assets.

With the moderate total debt level, the company can easily take on more debt if needed (for any future capital expenditure plans the company may have). I prefer companies with total liabilities under 50% of the total asset value - as this gives the company plenty of leeway before debt becomes excessive. When debt levels raise, so does the bankruptcy risk which is something I like to avoid when investing with a long-term view.

Salesforce.com operates with a minimal amount of working capital (with a current ratio of 0.95) meaning that its short-term assets (such as cash and deposits) do not quite cover its short-term liabilities (bills the company has to pay). I personally prefer current ratios above 1.0 so that the company's bills can be paid with cash rather than having to dip into its long-term finances.

Salesforce.com's forward PE multiple is 75x with a stock price of $155. The company's trailing PE multiple is 105x and its book value multiple is 7.6x. These multiples imply that Salesforce.com is expensive.

Salesforce.com has a significant history of growth with its revenue increasing 78% per year over the last decade. The chart below visually shows Salesforce.com's revenue and earnings trend over the last decade along with the next two years of consensus forecasts.

Salesforce revenue and earnings growth chart

Salesforce data by ADVFN

As the above chart shows, Salesforce.com's revenue has consistently increased over the last decade and the forecasts show this trend continuing into 2021/01. The earnings initially declined with losses through 2013/01 to 2015/01. The company's earnings then picked up and its growth is expected to continue into 2021/01.

Business Plans

Salesforce.com has been busy on the acquisition front having acquired four companies already this year. Last year, Salesforce.com acquired five companies.

The acquisitions so far this year include,

  • Bonobo, which provides a conversational platform that allows companies to analyse their communications.
  • MapAnything, which provides location-based intelligence solutions that improve field sales and employee productivity.
  • Salesforce.org, which is a reseller of Salesforce.com software and services to the nonprofit sector. Salesforce.org is a California public benefit corporation.
  • Griddable, which provides customers with the platform to synchronize enterprise data in the cloud.

While acquisitions have been a key driver for Salesforce.com's growth, the company also generates growth organically which management expects to continue, with Marc Benioff stating in their latest earnings call:

We expect this incredible growth to continue.

Organically doubling our revenue again in the next 4 years.

To help drive organic growth, Salesforce.com has partnered with Apple (AAPL) for developing apps. Apple and Salesforce are developing a mobile software developer's kit (SDK) so that businesses can use Salesforce.com's cloud-based software on mobile devices.

I think partnering with Apple is a good move as Apple's specialty is mobile devices and its programming language. Since the cloud gives remote access, it makes perfect sense for Salesforce.com to make its cloud services available on mobile devices. Apple will even be launching a new Get Started iOS App to assist software developers with building apps for Salesforce.com's cloud services.

Salesforce.com and Amazon's AWS (Amazon Web Services) (NASDAQ:AMZN) are offering a new set of data integration services for their common customers using the cloud. This will make it easier for customers to use more Salesforce.com applications on AWS, such as Salesforce.com's customer relationship management software.

To further its organic growth, Salesforce.com is finding international clients for their customer relationship management (CRM) cloud-based system, with Keith Block - Co-Chief Executive Officer, stating:

In Q4, we strengthened our relationships with some of the leading companies around the world from expanding with Toyota, National Australia Bank and Telstra and in Japan and Australia to form a brand new relationship, also in Germany with BASF, the world's largest chemical maker.

National Australia Bank is one of the biggest banks in Australia and will be replacing 13 existing systems with the Salesforce.com CRM platform. Salesforce.com and Telstra (OTCPK:TLSYY) (a dominate telecommunications company in Australia) have joined forces to deliver Salesforce.com's CRM applications to customers over Telstra's wireless networks.

Management is confident that Salesforce.com will continue to grow, with Mark Hawkins - President and CFO, stating:

We are raising our FY '20 revenue guidance by $50 million to $15.95 billion to $16.05 billion.

Whenever I see management raising their guidance, it tells me that they are confident in the company's ability. As an investor, I'm reliant on management's views. The projected growth is around 20% per year, which is quite high, but the company has grown significantly over 70% per year over the last decade. So, the projected growth rate is actually lower than its historical growth rate. I think that the company will likely continue expanding, even if its future earnings growth shows some volatility like it has in the past.

Stock Valuation

Salesforce.com has a history of revenue growth. The company's earnings have increased, although there were earnings losses for a number of years. Even with the losses, the average growth rate was still 74% per year. The forecast earnings growth rate is 20% heading into the 2021/01 fiscal year. The PEG (PE divided by the earnings growth rate) can be used to arrive at a valuation based on its earnings growth.

Using the forecast earnings growth rate of 20% gives a forward PEG of around 3.8 with a 2021/01 PE multiple of 75x.

It's commonly accepted that a stock is fairly valued when its forward PEG is 1.0 which means that Salesforce.com is overvalued with a stock price of $155. Its fair value would be around $40.

Most good growth stocks usually have forward PEG's in the 1.5 to 2.5 range, but Salesforce.com's forward PEG of 3.8 is expensive, even for a growth stock.

Stock Price

As an active investor, I personally like to determine some likely price targets. This gives me a feel for how high the stock price could go in the short term and how soon it could get there.

Salesforce ten year stock chart

Salesforce chart by StockCharts.com

Over the last decade, Salesforce.com's stock price has surged higher. The stock pulled back late last year as the stock market pulled back from its all-time high. The stock market resumed its rally this year and Salesforce.com rallied back up along with the market.

In the short term, the stock could rally some more and will probably do so as long as the market continues to rally. The strong 50% rallies seen during the last two years could be replicated again this year. Adding a 50% rally to the $120 low from late last year gives a target of $180 that could be reached within a year.

Salesforce.com has a history of strong growth and this growth is expected to continue. As the stock is quite expensive, I suspect that it will be vulnerable to corrections if future earnings disappoint the market. Over the longer term, I think that Salesforce.com has the potential to trade higher, but its high stock price for its earnings makes the stock vulnerable to significant corrections.

Conclusion

Salesforce.com derives its growth from a combination of organic growth and acquisitions (having acquired 4 companies so far this year and five companies last year). Salesforce.com has expanded significantly over the last decade with its revenue increasing at an average rate of 78% per year.

Salesforce.com has partnered with Apple to make its cloud-based software services available on mobile devices. The company continues to increase its client base internationally with Australian company National Australia Bank replacing older existing systems with Salesforce.com systems. Also, in Australia, Telstra will deliver CRM applications to customers over Telstra's wireless network.

While Salesforce.com has grown significantly, the stock is expensive with a forward PEG of 3.8 and a forward PE multiple of 75x. Management expects 20% per year growth, but the valuations are too high for my liking. I'm confident that management will deliver growth, but the stock is priced for perfection, and if future growth disappoints, the stock is vulnerable to a significant correction. Even halving the current stock price would still leave the company expensive but more acceptable from a valuation point of view.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.