Stock of the week - Salesforce (28.05.2024)

• Salesforce scheduled to report fiscal-Q1 2025 earnings this week
• Revenue growth is seen little changed compared to fiscal-Q4 2024
• Expected slowdown in remaining performance obligation growth looks worrisome
• Investors will focus on fiscal-Q2 2025 guidance
• Company has a solid track record of revenue and sales beats
• A look at valuation
• Stock pulled back from all-time highs recently

Salesforce (CRM.US) is one of the stocks to watch this week, as the company is scheduled to report its fiscal-Q1 2025 earnings on Wednesday after market close. Company has a strong track record of beating earnings and revenue expectations, but expected slowdown in remaining performance obligation growth is a source of concern. Let's take a quick look at what the market expects from the release, what to focus on and how Salesforce's valuation looks like!

Salesforce to report Q1 earnings this week

While Wall Street earnings season is almost over with more than 90% of large-cap US stock having already reported their results, there are still some well-known companies left to report. Salesforce is one of such companies, with fiscal-Q1 2025 quarter (calendar February - April 2024) report scheduled for release on Wednesday, May 29 after close of the market. 

Analysts expectations are for a double-digit revenue growth, more or less at the same level as in fiscal-Q4 2024, but slightly slower than in year ago quarter. Subscription & Support revenue is expected to remain a key driver of company's sales, with an over 90% share in total revenue. Integration & Analytics is expected to see the fastest sales growth. Expectations also point to improved efficiency, with cost of revenue growing much slower than sale and operating expenses dropping in spite of an expected increase in sales. This paves way for a large increase in earnings. Operating and free cash flow are also expected to improve significantly compared to a year ago.

Fiscal-Q1 2025 earnings expectations

• Revenue: $9.145 billion (+10.9% YoY)
  • Subscription & Support: $8.567 billion (+12.1% YoY)
    • Sales: $1.986 billion (+9.8% YoY)
    • Service: $2.188 billion (+11.4% YoY)
    • Platform & Other: $1.745 billion (+11.4% YoY)
    • Marketing & Commerce: $1.275 billion (+9.0% YoY)
    • Integration & Analytics: $1.359 billion (+20.2% YoY)
  • Professional Services & Other: $0.577 billion (-4.6% YoY)
• Cost of revenue: $2.195 billion (+3.3% YoY)
• Gross profit: $6.945 billion (+13.4% YoY)
  • Gross margin: 76.0% (74.2% a year ago)
• Operating expenses: $5.185 billion (-9.2% YoY)
• Operating income: $1.776 billion (+331% YoY)
  • Operating margin: 19.4% (5.0% a year ago)
• Pre-tax income: $1.848 billion (+467% YoY)
• Net income: $1.439 billion (+623% YoY)
  • Net margin: 15.5% (2.4% a year ago)
• EPS: $1.50 ($0.20 a year ago)
• Diluted EPS: $1.44 ($0.20 a year ago)
• Adjusted EPS: $2.38 ($1.69 a year ago)
• Operating cash flow: $5.491 billion (+22.3% YoY)
• Free cash flow: $5.334 billion (+25.6% YoY)
• Remaining performance obligation: $53.451 billion (+14.5% YoY)
  • Current: $26.774 billion (+11.1% YoY)
  • Non-Current: $26.582 billion (+17.6% YoY)

Salesforce revenue growth is seen staying more or less unchanged compared to fiscal-Q4 2024 pace. Professional Services & Other revenue is expected to drop much less than it did, but its share in total revenue is very small. Dashed lines mark expectations for fiscal-Q1 2024. Source: Bloomberg Finance LP, XTB Research

Revenue growth in Subscription & Support sub-sections are seen holding more or less unchanged compared to fiscal-Q4 2024. Dashed lines mark expectations for fiscal-Q1 2025. Source: Bloomberg Finance LP, XTB Research

What to focus on?

Headline results will be watched closely but given company's track record of beating expectations, another surprise cannot be ruled out and markets may be even positioning for one already. Having said that, guidance the company will offer for fiscal-Q2 2025 may be more important than fiscal-Q1 revenue figures. Also, investors will focus on remaining performance obligation data as it is expected to show a slowdown in growth, which may hint a weakness in new orders from customers, or in case of current remaining performance obligation, as weakness in renewals.

Company already said during fiscal-Q4 2024 earnings release that it does not expect to see a material contribution from generative AI to its business this year, but given that AI is the current market craze, investors will surely look for hints on it. Should the company provide a clear timeline on when it expects to see genAI improve revenue growth, it could be a trigger for share price gains (unless it will be a distant future).

Salesforce fiscal-Q1 2025 guidance

• Revenue: $9.120-9.170 billion
• Adjusted EPS: $2.37-2.39
• EPS: $1.42-1.44

Analysts expect a slowdown in Salesforce's remaining performance obligation growth in fiscal-Q1 2025, which may hint at weakness in new orders and renewal rates. Dashed lines mark expectations for fiscal-Q1 2025. Source: Bloomberg Finance LP, XTB Research

How the stock reacted to previous earnings releases?

Salesforce has a very good track record of beating analysts' expectations. Data on beats and misses in adjusted EPS and revenue figures for the past 20 quarterly releases can be found in the table below. As one can see, the company managed to beat profit and sales expectations in each of those quarters! The last time Salesforce failed to beat adjusted EPS expectations was in fiscal-Q4 2016 (calendar November 2015 - January 2016 quarter)!

However, a point to note is that even as Salesforce managed to beat profit and sales expectations, it was not always met with a positive price response during the post-earnings session. 

Average absolute post-earnings price change over the past 20 quarter is 6.49%. This is very close to the potential post-earnings share price move implied by options markets, which is 6.44%

Source: Bloomberg Finance LP, XTB Research

Looking at the past 8 quarterly releases, Salesforce stock gained on average in the first two days following release of the earnings report. However, average for the 3-5 days following the announcement was little-changed compared to pre-release price levels. Source: Bloomberg Finance LP

A look at valuation

Let's take a quick look at Salesforce's valuation with 2 often used valuation methods - DCF and multiples. We want to stress that those valuations are for presentation purposes only and should not be viewed as recommendations or target prices. 

Salesforce initiated a quarterly dividend of $0.40 per share following release of fiscal-2024, However, as the company did not outline a clear dividend strategy, it is hard to determine possible dividend growth rates. Having said that, the company is unsuitable to be valued using Gordon Growth Model, which we often use in our Stock of the Week posts.

Discounted Cash Flow method

Firstly, let's take a look at Salesforce valuation with one of the most popular fundamental models - Discounted Cash Flow method (DCF). This model relies on a number of assumptions, and we have decided to base those around 5-year averages, but with slight adjustments to make them more reflective of recent trends in data. This means adjusting revenue growth down to around 15% from 21.5% (5-year average) and boosting the operating margin assumption to around 10% from 5.2% (5-year average). However, it should be said that those assumptions are very conservative as the company has clearly shifted to higher margins over the past 2 years. After all, the company is expected to report an operating margin above 19% in fiscal-Q1 2025!. Forecasts for 10 years were made with terminal value assumptions being 4% terminal revenue growth and 10% weighted average cost of capital (WACC). Running the model with these assumptions leads us to an intrinsic price per Salesforce share of $192.77 - or almost 30% below Friday's closing price.

A point to note is that the intrinsic value obtained via the DCF method is highly sensitive to assumptions made. Two sensitivity matrices are provided below - one for different sets of Operating Margin and Revenue Growth assumptions and the other for different sets of Terminal WACC and Terminal Revenue Growth assumptions.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Multiples

Next, let's take a look at how Salesforce valuation compares with peers. We have created a peer group consisting of 7 companies - SAP (SAP.DE), Adobe (ADBE.US), Intuit (INTU.US), Synopsys (SNPS.US), Cadence Design Systems (CDNS.US), Freshworks (FRSH.US) and Oracle (ORCL.US). We have taken a look at 6 different multiples - P/E, P/BV, P/S, P/FCF, EV/Sales and EV/EBITDA.

As one can see in the table below, there is significant volatility in the multiples for Salesforce peers. While in case of P/E the dispersion between mean, median and cap-weighted averages is rather small, it is quite significant in case of P/BV multiples. We have calculated Salesforce valuations based on all three averages (mean, median and cap-weighted). A point to note is that regardless of which type of average we choose, valuation obtained are significantly higher than Friday's closing prices.

Source: Bloomberg Finance LP, XTB Research

A look at the chart

Last but not least, let's take a look at the situation on the chart. Taking a look at Salesforce (CRM.US) chart at D1 interval, we can see that the company reach fresh all-time highs at the beginning of March 2024, but has struggled since. Stock pulled back to the 23.6% retracement of the upward move launched at the turn of 2022 and 2023, where the pullback was halted. However, bulls struggled to revive uptrend later on and the company continues to trade near the aforementioned retracement.

Source: xStation5