Salesforce: Will its Strong Q1 Change The Negative Sentiment Surrounding Shares?
Salesforce (CRM), one of the premiere growth companies in the technology space in recent years, has struggled throughout 2021 thus far. Prior to its first quarter earnings report last week, shares were up just 2%, underperforming the S&P 500’s year-to-date gains of 12% by a wide margin. This underperformance is relatively rare for CRM shares, whose total returns have more than doubled the S&P 500’s over the last 5 and 10-year periods. However, the company beat Wall Street estimates on both the top and bottom lines during its Q1 report, which sent shares on a 6% rally. And now that the Q1 dust has settled, we wanted to take a look at what the blue chip analysts that the Nobias algorithm tracks have to say about this stock. Were the first quarter results strong enough to change the sentiment surrounding Salesforce? Let’s find out!
Before we get into the analysts’ opinions, we wanted to begin with Salesforce’s Q1 conference call, highlighting some commentary from the company’s senior management. During Q1 Salesforce produced revenue of $5.96 billion, which was up 23% year-over-year. The company’s operating cash flow came in at $3.23 billion, up 74% year-over-year.
CRM’s CEO, Mark Benioff began the Q1 conference call on a very upbeat nore, saying, “It was just incredible. It was beyond our expectation. It's not just the best first quarter we've ever had. I think it's the best quarter we've ever had.” Not only was Benioff bullish on the Q1 results, but he noted that his company was guiding for 21% revenue growth in Q2, pointing towards continued momentum in the short-term, and that Salesforce was raising full-year 2022 guidance as well. Now, CRM is calling for $26 billion in revenue next year, which represents 22% year-over-year growth relative to 2021 expectations. What’s more, CRM’s management expects to see operating margins improve by 50 basis points in 2022 as well, pointing towards not only higher sales, but higher profitability as well.
This is good news for investors who’re basing their CRM valuations on the bold statement that Benioff made about long-term growth during the Q4 2020 earnings presentation last year regarding Saleforces’ 5-year growth plan. During the Q4 presentation, Benioff said, “And as we shared at our Investor Day last year, our long-term revenue target for the fiscal year 2026 is now $50 billion or basically we're going to double the company from where we are right now. That is doubling revenue in five years, and we'll reach that milestone faster than any other enterprise software company. That would make Salesforce the second largest independent software company in the world, amazing.”
During the Q1 conference call last week, he doubled down on this guidance, saying, “And in a few years, we're going to be doing $50 billion, and by fiscal year 2026. So that is an incredible thing. I mean, we're really seeing some momentum and some cadence that's very powerful for the company.” This guidance calls for sales to compound at a roughly 19% rate from 2021-2026. This sort of growth from a company coming from a company with a $217 billion market cap would be very impressive (and unique). And yet, even with this growth in mind, the question remains, is it already priced into the stock?
Vladimir Dimitrov, a Nobias 4-star rated analyst who writes for Seeking Alpha, has published concerns regarding CRM’s valuation in the past. In September of 2020, he published this article, in which he said CRM was likely to underperform in the near-term, due to valuation concerns. And, as it turns out, he was spot on. Since September CRM has underperformed the market by a wide margin. Dimitrov recently published another article on Salesforce, titled, “Salesforce Will Continue To Grow, But Returns Will Most Likely Disappoint”, in which he revisits that prior thesis and updates his outlook now that shares have lagged.
In this piece, Dimitrov says, “Salesforce is an undisputed leader the CRM space and is becoming a dominant player in other adjacencies, such as Digital Commerce, Business Intelligence, and other Platform-as-a-Service areas.” However, he continues to express concerns about the company’s ability to grow in a tighter economic environment, offering specific criticism of the company’s bottom-line performance and growth prospects. With regard to monetary policy, Dimitrov says, “As extremely loose monetary policy brought yields close to the zero bound, high-growth momentum has become the place to be in the yield-starved world where central banks were always there to put a floor under risky assets and ceilings on credit spreads and volatility. As a result, high-growth momentum stocks significantly outperformed value companies over the past decade.”
It’s clear that Salesforce has benefitted from regular M&A activity and there are questions about whether or not this inorganic growth strategy is reliable in a rising rate environment. In this regard, Dimitrov believes that the company is going to have to show a renewed sense of discipline moving forward, saying, “By focusing on acquiring complementary businesses with very high growth rates, CRM has secured its topline growth for years to come, but there is a catch to this strategy. It also involves paying hefty premiums of these high-growing businesses, and sooner or later, CRM will need to show some impressive profitability numbers in order to justify these deals and its current valuation.”
He shows that while Salesforce continues to dominate market share in the customer relationship management space, the company continues to lag peers such as Adobe, Microsoft, SAP, and Oracle in terms of profitability. A lot of this appears to be driven by the company’s high marketing spend. And while scale is incredibly important, Dimitrov wonders whether or not Salesforce will be able to maintain its leadership without a high marketing spend and ongoing M&A activity, both of which appear to place hurdles between the company and the profits that are required to justify its current premium.
Dimitrov says, “After years of high M&A activity, CRM has by far the largest gap between its achieved profitability and its forward Price-to-Earnings ratio within its peer set.” He continues, “This leaves a serious question for shareholders and namely: can Salesforce become significantly more profitable in the future, without sacrificing growth and market share?”
Overall, Dimitrov maintains his cautious stance. He acknowledges CRM’s strong standing amongst its peers, its operational strength, and its top-line growth prospects; yet, he isn’t sold on the idea that the stock’s share price performance will match its revenue growth moving forward because of valuation concerns. He concludes his piece saying, “In other words, there is a possibility that CRM could trade around these levels for years, even if it delivers on its ambitious revenue growth targets and in the process achieves best-in-class profitability without diluting shareholders.”
Now, not everyone is quite so cautious. In a recent podcast, Nobias 5-star rated analyst, Brain Withers of The Motley Fool, discussed Saleforce’s recent Slack acquisition, highlighting the attractive growth that Slack is likely to bring to the table for Salesforce. With regard to Slack’s recent earnings results, Wither’s said, “Earnings was pretty decent, revenue was $903 million for full-year 2020, so they're approaching a $1 billion run rate business, it's up 43%, Q4 was up 38%, so pretty strong. Billings are up 41% showing me that customers are still signing up for Slack even though everybody knows that Salesforce is going to buy them, that isn't slowing growth at all.”
Nicholas Ward is a Senior Investment Analyst at Wide Moat Research. He has spent the last 8 years writing about the stock market at various publications, including Seeking Alpha, The Street, Forbes Real Estate Investor, Sure Dividend, The Dividend Kings, iREIT, Safe High Yield, and The Intelligent Dividend Investor.
Simply Wall Street, a Nobias 5-star rated analyst recently published an article on Nasdaq.com highlighting CRM’s M&A activity and the impact that it has had on the company’s balance sheet. Their conclusion was bullish as well, saying, “We could understand if investors are concerned about salesforce.com's liabilities, but we can be reassured by the fact it has has net cash of US$9.29b. And it impressed us with free cash flow of US$4.1b, being 711% of its EBIT. So we are not troubled with salesforce.com's debt use”.
And lastly, in response to Salesforce’s Q1 results, we saw that Morgan Stanley analyst, Keith Weiss, upgraded CRM from an equal weight rating to overweight, raising his price target to $270/share (right now, CRM trades for $236.20, meaning that Weiss’s target implies upside potential of 14.3%).
Weiss said that Salesforce was “getting back its mojo” with rising bookings showing increased demand, which is likely to continue due to the strengthening economic outlook coming out of the pandemic. Like Withers, Weiss also offered positive commentary on the Slack deal, saying that demand trends justify the “strategic rationale” that Salesforce expressed when it spent $27.7 billion to acquire Slack.
In recent months, we’ve tracked 5 opinions published by analysts with 4 and 5-star ratings and overall, the sentiment that the Nobias algorithm tracks remains positive here. 4 out of the 5 opinions offered by blue chip analysts were bullish, which appears to point towards more upside momentum for CRM shares.
Disclosure: Nicholas Ward is long CRM and MSFT. Nicholas Ward wrote this article for Nobias at their request with a view of giving investors a balanced perspective based on the writings of Nobias highly rated analysts and bloggers. Nobias has no business relationship with any company whose stock is mentioned in this article and does not have a position in this stock.
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