Salesforce: Down ~40% From High, It's A Strong Buy

Aug. 10, 2022 4:32 PM ETSalesforce, Inc. (CRM)20 Comments
Michael Fitzsimmons profile picture
Michael Fitzsimmons
18.82K Followers

Summary

  • The stock of Salesforce is down ~40% from its high of $309 back in November. That offers opportunistic investors a great chance to buy some shares.
  • That's because company fundamentals are strong, financial results are solid, and CRM's business model is proving to be much more resilient than the market gives it credit for.
  • Investors have been overly pessimistic in my opinion. Yes, the strong U.S. dollar is a headwind, but the company continues to generate strong FCF and margin expansion is impressive.
  • Salesforce is a BUY and could easily regain the $300 level over the next 12-months. That would be a 60% gain from the current $188 stock price.

Salesforce New York City

wdstock

The stock of Salesforce (NYSE:CRM) has fallen ~40% from its perch over $300 last November to its current $188. In my opinion, the sell-off is irrational and investors are significantly underestimating the potential of CRM's platform and its ability to grow top-line revenue while expanding margins and deliver strong growth in FCF. Salesforce's recent earnings report demonstrated why I am so bullish. And while I readily concede the recent strong U.S. dollar is a headwind (FX had a 2% negative pull on Q1 FY23), I would point out that Salesforce recently raised its full-year non-GAAP operating margin guidance. Salesforce remains one of my favorite software picks for its long-term growth potential and its ability to leverage its SaaS-based platform to generate excellent free-cash-flow as it scales-up the business while expanding margin.

Earnings

Back in May, Salesforce delivered what I considered to be a very solid (if not outright bullish...), Q1 FY23 EPS report. The results were a beat on both the top- and bottom-lines. Highlights included:

  • Non-GAAP EPS of $0.98/share (a $0.04 beat).
  • Revenue of $7.41B (+24.3% Y/Y) beat by $30 million, even with a 2% negative impact due to FX (foreign exchange) considerations.
  • Operating Cash Flow of $3.68 Billion was up 14% yoy.

Better still, free-cash-flow was $3.5 billion - a whopping 47% of revenue and an estimated $3.50/share. FCF generation was up $440 million yoy and is clearly demonstrates the power Salesforce has in very efficiently scaling up its SaaS-based business model.

In addition, note that Salesforce is hitting on all cylinders: it demonstrated double-digit growth across all its operating segments during the quarter:

Saleforce Segment Results

Salesforce

Source: Q2 FY23 Presentation

Sales Cloud grew 20% yoy, which was a very impressive acceleration both on a yoy and sequential basis. Note also that the Platform & Other Segment includes Slack (best-in-class messaging & collaboration, but short-term drag on margins), and was up 58% yoy on a constant currency basis.

Going Forward

Salesforce initiated Q2 FY23 revenue guidance in a range of $7.69 to $7.70 billion. That would be up ~21% yoy. Meantime, it raised full-year FY23 revenue guidance to $31.7 - $31.8 Billion, or up ~20% yoy.

Even better, and despite the challenging operating environment, Salesforce also raised FY23 GAAP Operating Margin Guidance to ~3.8% and Non-GAAP Operating Margin Guidance to ~20.4%. So, not only does CRM's FCF generation profile demonstrate the company's ability to efficiently scale up the platform, but margin expansion also supports that thesis (i.e. FCF growth and margin expansion go hand-in-hand).

As a result of the EPS report and raised guidance, note that downward earnings revisions have stopped:

CRM EPS Estimates

Yahoo Finance

To me, that means sentiment has changed and the stock has likely bottomed here. Indeed, a better than expected inflation report this morning has the US$ Index down 1.35% and CRM stock moving sharply higher at pixel time (+$6.41 or +3.52%) :

Chart
Data by YCharts

Perhaps investors are beginning to realize that while Salesforce's top-line revenue growth may have slowed as compared to the past, the company's strong and ongoing margin expansion means it can likely grow earnings at a 20% CAGR for years to come. Salesforce expects to generate ~$6.65 billion in FCF for FY23 (+29% yoy).

Meantime, as Co-CEO Bret Taylor said on the Q1 conference call, the current pipeline looking into the 2H is strong and, despite the naysayers, Slack is actually turning out better than Salesforce itself expected:

As you know, we've been working through some issues on MuleSoft's go-to-market motion over the past couple of quarters. Amy will get into specifics, but I'm encouraged by the progress we're making, and we have a strong pipeline for the back half of the year. I'm also excited to say that Slack continues to exceed our revenue expectations, with wins of the self-driving car company, Cruise and the UK Ministry of Justice.

On the investment side, Salesforce continues to embrace technology to grow its business by adopting marketing automation, e-commerce, its integrated "Einstein AI" platform, and analytics where applicable throughout its platform.

Valuation

Even after the big decline in the stock price, Salesforce still trades at a market premium P/E = 38x. However, as most investors realize, P/E is not the way to look at a company that is still growing at a fast rate and continues to scale-up a SaaS-based model that is already delivering excellent free-cash-flow, durable and strong revenue growth, and for which margin expansion is still the primary investment thesis going forward (at least in my opinion). And the entire platform is supported by a very solid and sticky ARR-based business model.

My FY23 price target for Salesforce is $300 (up 60% from here). That's roughly a 10x EV/Sales multiple, an adjusted P/E of ~60x, and roughly a 3% FCF yield. In my opinion, those valuation levels are fully justified by an estimated 5-year CAGR rate of 15-20% with non-GAAP operating margin rising from 19% last year to an estimated ~25% in FY25.

Risks

Risks to Salesforce include the law-of-large-numbers. That is, the company has grown to such a scale that continuing top-line growth of 20% will become increasingly challenging going forward (thus my estimate of 15-20% over the next 5-years). However, I would point back to the margin expansion story and the strong leverage the company has in scaling up its SaaS-based model very efficiently and into a free-cash-flow generating monster.

Given the top-line challenge, CRM may continue to turn to acquisitions to power growth going forward (ala increasing its TAM via recent deals for Slack, MuleSoft, and Tableau, for example). Deals like that pose risks from an integration standpoint and could also lead to overpaying and to shareholder dilution.

Salesforce has a very strong balance sheet and ended the most recent quarter with $13.5 billion in cash & cash equivalents and $9.6 billion in debt, for a net-cash position of $3.9 billion (or an estimated $3.90/share).

Summary & Conclusion

Salesforce was one of the earliest and most disruptive companies to leverage the power of a cloud-based SaaS business model. Since then, CRM's organic and M&A strategy have evolved its platform into the most comprehensive set of feature-rich solutions for medium sized businesses all the way up to the largest enterprise companies on the planet. Revenue continues to grow at a fast-clip and FCF generation in the most recent quarter was $3.5 billion (a whopping 47% of revenue) and an estimated $3.50/share.

Salesforce is a BUY and my FY23 price target is $300/share, or up 60% from here. The company is scheduled to announce Q2 results in two-weeks, after the market closes on August 24th. I suggest investors buy the dip in CRM stock prior to that EPS report, which I believe will - once again - be quite strong (both financially and with the accompanying management commentary), and likely stronger than the excellent Q1 report reviewed above.

I'll end with a 5-year price chart of CRM and note the stock appears to have bottomed and to have formed a coiled-spring base in which to jump higher:

Chart
Data by YCharts

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This article was written by

Michael Fitzsimmons profile picture
18.82K Followers
Technology stocks, ETFs, portfolio strategy, renewable energy, and O&G companies. Primary goal is growing net-worth. I typically allocate a portion of my own portfolio and devote some of my SA articles to small and medium sized companies offering compelling risk/reward propositions. I am an Electronics Engineer, not a qualified investment advisor. While the information and data presented in my articles are obtained from company documents and/or sources believed to be reliable, they have not been independently verified. Therefore, I cannot guarantee its accuracy. I advise investors conduct their own research and due-diligence and to consult a qualified investment advisor. I explicitly disclaim any liability that may arise from investment decisions you make based on my articles. Thanks for reading and I wish you much investment success!

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article were obtained from company documents and/or sources believed to be reliable, but have not been independently verified. Therefore, the author cannot guarantee their accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for the investment decisions you make.

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