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It has been a long time since I last looked at Salesforce (NYSE:CRM). In fact, it was the summer of 2019 when I concluded that data was pricey, but so was a prospect $15 billion deal for Tableau. Fast forward three years in time, we have seen continued and impressive topline sales growth, realistic profits and a stagnant share price, all improving relative appeal. Note that I use the word relative appeal, as absolute earnings multiple remain nosebleed high, even amidst continued sales and margin growth.
Former Take
Back in the summer of 2019, Salesforce announced a huge + $15 billion deal for Tableau, a deal paid for in shares as added expertise and growth of Salesforce has been driven by dealmaking efforts. While I was not a big fan of the heavily adjusted earnings numbers, I was very respectful of the operational performance of the company under the leadership of Marc Benioff, making it a very dangerous company to bet against. This is despite the lack of realistic earnings, as the long term potential of end markets is large, and the company is one of the undisputed leaders here.
The deal for Tableau combined the leading CRM solution of Salesforce with a data analytics platform under a single roof. Shares of Salesforce traded at $161 at the time, which translated into a $125 billion enterprise valuation, for about an 8 times sales multiple with revenues seen around $16 billion at the time.
Topline sales growth of 20% was solid, as it has been for years, yet the GAAP earnings were never really there, and while adjusted earnings started to look decent, realistic earnings were still not really there with stock-based compensation being a huge and consistent adjustment factor.
What Happened?
Fast forward three years in time, we see shares now trade at $175, marking a modest 10% gain over the time frame of about three years, resulting in underperformance versus the wider markets over this period of time. This is in part explained as shares have fallen victim to the pullback in technology names, with shares of Salesforce actually trading hands at over $300 per share little over half a year ago.
These modest returns have been seen while Salesforce has been seeing solid growth in recent years. In March, Salesforce posted $26.5 billion in sales for 2021, up a decent 24%, and with the company guiding for $32 billion in sales in 2022, sales would double from 2019. That is partially outdone by continued dilution as the share count has been inching up towards the billion mark, marking some 25% dilution since 2019 as sales will double over the same period of time, as dilution has limited the growth on a per-share basis somewhat.
The bright news is that the company has turned GAAP profitable and operating earnings came in at $548 million in 2021, as GAAP earnings of $1.4 billion were inflated by gains on strategic investments. Between the GAAP earnings number of $1.48 per share and the adjusted number of $4.78 per share were some big items. While I am not happy to adjust for nearly $3 per share in stock-based compensation expense, I am happy to adjust for $1.67 per share in amortization charges. Adding this to the roughly half a dollar in GAAP operating profits, I peg realistic earnings at around $2 per share.
That still reveals a huge multiple as nearly a billion shares trade at $175, for a near 100 times realistic earnings multiple, albeit the company has seen sales multiples contract to about 6 times trailing sales, and slightly less than that based on the 2022 guidance. Besides guiding for about $32 billion sales this year, the company sees GAAP operating margins around 3.6%, translating into roughly a billion in operating profits, as realistic operating margins are seen around 10%, or $3 billion. This could create earnings north of $2 per share, but still translates into huge valuation multiples.
In May, Salesforce posted first quarter results more or less in line with expectations. The full year sales guidance was cut to $31.7-$31.8 billion, but this is nothing more than factoring in the impact of a strong dollar. The company has hiked the operating margin guidance by 20 basis points to 3.8%, and is back to seeing a modest net cash position again, following dealmaking efforts in recent years.
And Now?
Investing is all about performing a balancing act. The truth of the matter is that Salesforce is the undisputed leader in its field, and has grown rapidly, by combining organic growth with function-adding deals. The pace of growth is very solid for such a big firm, and fortunately, we have seen some real GAAP profits as well, although too small to create a reasonable valuation multiple. This is important as the time of realistic losses are a thing of the past, no longer creating additional dilution for shareholders on that front.
Given that sales doubled in about 4 years time, while relatively modest dilution has been incurred and shares have been trading largely stagnant, valuations have arguably improved, but we still have to see realistic earnings multiples here. Even if I kindly use a $2.50 per share number on that metric in 2022, a resulting near 80 times earnings multiple translates into a sky-high valuation and an earnings yield just over 1 percent, far too low to create appeal in this interest rate environment.
This conclusion still leaves me cautious, although I am more constructive on the name than I have been in a long time, but fortunately we are still a long way from seeing an interesting entry point here. Using 15% realistic operating margins on $40 billion in sales in the coming years as quite an ambitious target, the business could post $4-5 billion in net profits after taxes. Such a potential performance would still work down to a 35 times earnings on the higher end of the range, leaving it easy to conclude that valuations are still a bit too demanding.
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