Is Salesforce Stock Undervalued Or Overvalued? (NYSE:CRM)

Salesforce Blue Cloud-Logo

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Although Salesforce (NYSE:CRM) is heralded as the global leader in providing cloud-based customer relationship management (“CRM”) solutions, its stock certainly does not trade like one. Despite its strong track record in sustained operational growth, the Salesforce stock remains significantly undervalued when compared to SaaS peers with a similar growth profile.

The Salesforce stock has been on a consistent decline since the start of the year, shedding more than 25% of its value. Despite a strong beat-and-raise reported during its fiscal 2022 earnings call in early March, the stock was unable to hold its momentum, sliding close to 10% since. Investors seem to still be punishing the stock for its modest “current remaining performance obligation” (“CRPO”) growth miss from the previous year’s fiscal third quarter, and nominal softening in gross profit margins during the fiscal fourth quarter due to continued integration of newly acquired assets like communications platform Slack. The brewing macroeconomic and geopolitical situation, which remains fluid, is also not boding well for valuations across the broader SaaS industry.

But considering Salesforce’s market leadership within a strong demand environment underpinned by accelerated corporate IT spend to keep up with digital transformation trends, the stock remains an attractive long-term investment. Its strong free cash flow and operational cash flow growth profile also cushions some of the macroeconomic impacts on valuation stemming from a potential economic downturn in the near-term due to tightening monetary policies ahead. Salesforce’s stock remains a core, long-term SaaS holding with more room to run, especially given its discounted valuation to the “large-cap peer group”, which is non-reflective of its current operational strength and growth profile.

Why Has the Salesforce Stock Been Dropping?

The record-breaking inflation prints that have been emerging since late last year have made it clear that the post-pandemic price increases are not going to be as “transitory” as the Fed had initially expected. This accordingly paved grounds for a 180-pivot in the Fed’s stance on quelling inflation, which included plans for an aggressive rate hike cycle, creating a risk-off environment for equities. Growth stocks like Salesforce have been the hardest hit in the monthslong market rout due to market concerns that aggressive rate hikes ahead could risk eroding the present value of its future earnings, while also increasing borrowing costs for capital to fund future growth investments.

As a result, heading for the exits at the first hint of weakness has been the common denominator observed in equity investing in recent months. The same was observed in late November after Salesforce missed the consensus estimate for its fiscal third quarter CRPO growth – a key metric for next 12 month sales – and earnings. The stock lost more than 12% of its value overnight, marking the beginning of what is now the fifth month of consistent declines for Salesforce since its market valuation peaked in early November. Even a solid beat-and-raise for the fiscal fourth quarter reported in early March did little to bring back the stock’s upward momentum – possibly due to the bad mix of a softer-than-expected margin profile driven by early-stage integration of newly acquired assets, alongside broad-based market headwinds.

Is Salesforce Expected to Grow?

It has been a bit of a paradoxical time for growth stocks, especially those like Salesforce which has been on a steady decline despite delivering quality earnings and a strong, sustainable long-term growth profile. Because of Salesforce’s market leadership in the provision of cloud-based CRM solutions built over the past two-plus decades, it is one of the best-positioned to consolidate and capitalize on accelerating corporate IT spend in coming years.

While digital transformation had already been an emerging trend since before the onset of the pandemic, the ensuing disruptions to status-quo working, learning and collaborative conditions have accelerated the process of adopting digital technologies by at least three years. The pandemic has proven the capability of technology in enabling rapid and effective response to changing working conditions, and has encouraged the corporate sector to rethink the role of digital transformation in driving “better economic outcomes”. And those that have failed to “invest in the areas of their business models that are most at risk of digital disruption” have largely fallen behind the pact in an ever-evolving business environment.

With only 11% of the corporate landscape feeling confident that their legacy business models will be “economically viable through 2023” and another 64% raising the need to step up on digitization plans, corporate spending on digital transformation is fast approaching an inflection point. And the favourable trends continue to support a strong demand environment for SaaS leaders like Salesforce, even under a potentially tightening economic environment in the near-term. More than half of the corporate scene have expressed that they would rather “tighten the belt” in other parts of the business than to miss out on digital transformation, which is considered a strategic investment in differentiating themselves from competitors, while also enabling cost efficiencies.

And Salesforce continues to be well-positioned for capitalizing on the industry’s rapidly increasing need for reliable, easy-to-use and integrated cloud-based CRM solutions. For instance, the rapid consumer shift to online e-commerce during the pandemic has increased the number of businesses that have reported at least 80% of their customer interactions online by threefold compared to pre-pandemic levels. The figure underscores surging demand for “connected omnichannel engagement” solutions like Salesforce’s Service Cloud, which is also corroborated by the segment’s impressive sales increase of 20% year-on-year observed during fiscal 2022 despite its scale and maturity.

The company’s ongoing expansion of its cloud-based CRM solution offerings also complements its “land and expand” business strategy in driving higher annual recurring revenues (“ARR”). For instance, its recent acquisition and integration of business communications platform Slack bodes well with the rising importance of cloud-based collaborative tools in the post-pandemic era to accommodate the increasingly hybrid working and learning environment. The ability to seamlessly integrate Slack for existing Salesforce customers allows the company to cross- and up-sell offerings to new and existing customers. Salesforce’s recent integration of the Einstein AI platform into its solutions portfolio, which enables predictions and recommendations by applying machine learning capabilities in data analytics, also resonates with increasing customer demand for tools to make sense of their massive data troves. To date, only 4% of companies claim to have a “highly sophisticated approach to leveraging data”. This leaves a sizable addressable market within the corporate environment in which Salesforce could penetrate.

And the strategic build-out of its cloud-based CRM offerings has continued to track favourably, especially in recent years due to accelerated digital transformation needs across all industries. More than 77% of Salesforce’s incremental ARR acquired in FY 2021 were from its existing customer base (FY 2020: 76%) and more than 93% of its customer base are now hooked onto multiple cloud-based CRM solutions offered by the company. The results underscore how an expanding product portfolio continues to reinforce sustained growth and market penetration for Salesforce through an effective land and expand corporate strategy.

Fundamental Growth Prospects

Drawing on Salesforce’s past performance and its forward-looking growth opportunities stemming from accelerating digitization demand as discussed in the foregoing analysis, the company’s topline is expected to expand at a compounded annual growth rate (“CAGR”) of 14% over the next five years and reach total sales of more than $50 billion by FY 2026. The growth assumptions applied considers Salesforce’s industry-leading ARR growth buoyed by continued expansion and integration of new CRM solutions into its existing product portfolio, and is consistent with management’s long-term growth target set out for the company per its latest investor presentation.

Salesforce Revenue Growth Forecast

Salesforce Revenue Growth Forecast (Author)

Salesforce Revenue Growth Forecast

Salesforce Revenue Growth Forecast (Author)

Much of Salesforce’s revenue growth will continue to be driven by its Sales Cloud, Service Cloud and Platform solutions segments, which houses some of the most critical CRM solutions demanded by the corporate sector over coming years. These include cloud-based end-to-end sales management tools (Sales Cloud), digital customer service and engagement / recommendation tools (Service Cloud), and cloud-based collaboration and productivity tools (Platform / Slack), which will be essential for enabling customers’ digital transformation trajectories over the longer-term.

Salesforce Financial Projections

Salesforce Financial Projections (Author)

Salesforce_-_Forecasted_Financial_Information.pdf

Is Salesforce Stock Undervalued?

Bottomline answer: yes, Salesforce’s stock is undervalued. Not only is Salesforce currently trading at a significant discount to its large-cap SaaS peers that exhibit similar growth profiles, but its current market valuation is also not reflective of its ability to generate sustained sales and market share growth while maintaining robust free cash flow margins.

Salesforce Peer Comp CY/2022

Salesforce Peer Comp CY/2022 (Author)

Salesforce Peer Comp CY/2023

Salesforce Peer Comp CY/2023 (Author)

By equally weighing an EV/sales-based and discounted cash flow (“DCF”) valuation approach, we have determined a base case price target of $314 for the stock. This spells upside potential of 66% based on the stock’s last traded share price of $189.41 on April 14th.

Salesforce Valuation Analysis

Salesforce Valuation Analysis (Author)

Salesforce Valuation Analysis

Salesforce Valuation Analysis (Author)

For the EV/sales-based valuation approach, we have averaged the PT derived by applying 9.2x and 7.4x to projected FY 2023 and FY 2024 revenues, respectively. The multiples applied are higher than the discount in which the stock is currently trading at (CY/2022: 6.5x; CY/2023: 5.5x), and are derived based on the growth-to-valuation correlation plot above. The EV/sales multiples applied in our valuation analysis aims to better align the stock’s potential with the broader SaaS peer group, which is more reflective of Salesforce’s market leadership in the provision of cloud-based CRM solutions and its higher growth profile.

Salesforce Valuation Analysis

Salesforce Valuation Analysis (Author)

Salesforce Valuation Analysis

Salesforce Valuation Analysis (Author)

For the DCF approach, we have drawn the projected cash flow streams from the base case fundamental forecast discussed in earlier sections, and applied an exit multiple of 46.6x (vs. 48.4x to 67.8x peer average, and Salesforce current trading multiple of about 24x) and a WACC of 13.8%. The valuation assumptions applied are consistent with Salesforce’s leading market share and higher growth profile compared to its peer group. It also considers the company’s capital structure and continued ability in delivering robust free cash flow margin growth to fund its longer-term growth strategy.

Salesforce Valuation Analysis

Salesforce Valuation Analysis (Author)

Salesforce Valuation Analysis

Salesforce Valuation Analysis (Author)

Is Salesforce Stock a Buy, Sell or Hold?

To reiterate our earlier thesis, we believe Salesforce is a core long-term SaaS investment capable of promising returns given its market leadership in critical CRM solutions that underpin current and future corporate digitization trends, as well as its high growth profile alongside a strong balance sheet. Despite the current macroeconomic overhang on risk assets like growth stocks, Salesforce continues to demonstrate fundamental strength, which will be a key focal point for investors ahead of the upcoming earnings season. However, the stock will likely see some continued turbulence in the near-term due to mounting macroeconomic uncertainties that remain unresolved, as well as an impending half-point rate hike – the first in 22 years – which could wreak havoc on equities coming in May before the waters calm again.

Author’s Note: Thank you for reading my analysis. Please note that we will be launching a Livy Investment Research Marketplace service on March 31st. The service will allow you to follow my coverage portfolio, interact with me directly, and participate in chat rooms with other subscribers. Early subscribers will receive a legacy discount at $249 per year. Stay tuned for more details as we ramp up to launch in the coming months.

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