Salesforce Will Benefit From Digital Transformation Acceleration

Steve Auger2020-08-05

SummarySalesforce has strong free cash flow margin and nearly $10 billion in cash and cash equivalents.Revenue growth of 30% is also exceptional for a company with revenue exceeding $18 billion.The ...

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I believe that the stock is a smart investment for the current economic conditions.","collect":0,"end_time":0,"defaultTopTitle":"seekingalpha.com","property":["earning"],"viewcount":null,"language":"en","relate_stocks":{"CRM":"赛富时"},"translate_title":"Salesforce将受益于数字化转型加速","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"CRM":1},"content_text":"SummarySalesforce has strong free cash flow margin and nearly $10 billion in cash and cash equivalents.Revenue growth of 30% is also exceptional for a company with revenue exceeding $18 billion.The company will most certainly come out of the pandemic and recession in excellent shape.Salesforce's stock price has broken out to an all-time high. I believe that the stock is a smart investment for the current economic conditions.Salesforce.com (CRM) is considered to be the granddaddy of Software-as-a-Service (SaaS) and a major force in the paradigm shift called digital transformation. But there is much negativity surrounding this company, with some analysts believing that Salesforce's best days are behind it. While it is true that Salesforce is achieving a portion of its growth via acquisition, this should not diminish its stature as a leader during these uncertain times when digital transformation is dramatically accelerating due to the pandemic-driven work-from-home phenomenon. With Salesforce’s strong free cash flow margin of 23% and nearly $10 billion in cash and cash equivalents, this is a conservative company that investors should consider investing in.  (Source: Salesforce) While most other companies have withdrawn guidance for the remainder of the year, Salesforce management has confidently provided positive guidance with revenue ~$20 billion, up from $17.1 billion the previous year. Operating cash flow is expected to grow by 10% to 11%, and free cash flow is expected to grow by 13% to 14%. Given that Salesforce generally does not miss analysts’ estimates, I take comfort in this company’s prospects for the coming year. \n (Source: portfolio123) Not only is Salesforce in a good position to weather the pandemic and global recession, but Mr. Market is signaling bullishness as the stock price has now broken out to an all-time high.  (Source: Yahoo Finance/MS Paint) For me, the vote of confidence from Mr. Market makes Salesforce an easy investment choice. This company’s revenue growth will likely exceed 20% in a very dismal economic environment. And an already strong free cash flow is expected to grow by double digits. I also find that Salesforce is undervalued relative to its software peers. For these reasons, I am assigning a buy rating for Salesforce. The Rule of 40 One industry metric that is often used for software companies is the Rule of 40. The rule provides a single metric for evaluating both high-growth companies that aren't profitable and mature companies that have lower growth but are profitable. Revenue growth and profitability (expressed as a margin) must add up to at least 40% in order to fulfill the rule. Analysts use various figures for profitability. I use the free cash flow margin. The rationale for the Rule of 40 is as follows. If a company grows by more than 40% annually, then you can tolerate some level of negative free cash flow. But if a company grows by less than 40%, then it should have a positive free cash flow to make up for the less-than-ideal growth. This rule accommodates both young, high-growth companies as well as mature, moderate-growth companies. The 40% threshold is somewhat arbitrary but typically divides the digital transformation stock universe in half, separating the best stocks from the so-so ones. For a further description of the rule and calculation, please refer to a previous article I have written.\n The two factors required for calculating the Rule of 40 are revenue growth and free cash flow margin. Salesforce's annual revenue growth for the last year was 30%, while its free cash flow margin was a strong 23%.  (Source: Portfolio123/MS Paint) Therefore, the Rule of 40 calculation for Salesforce is as follows: Revenue Growth + FCF margin = 30% + 23% = 53% Salesforce's score fulfills the Rule of 40, suggesting that Salesforce has a healthy balance between growth and profitability. Now critics are going to jump all over this because the Rule of 40 has traditionally been calculated based on organic growth. As I pointed out earlier, Salesforce achieves a fair proportion of its growth via acquisition. In all fairness, there are very few SaaS companies that still grow entirely organically. As a compromise, one could subtract share dilution. In the case of Salesforce, share dilution was 16% over the last year.  This results in a modified score on the Rule of 40: 53% - 16% = 37% While the share dilution was significant, the modified score is very close to 40% and I wouldn’t discount an investment based on this factor alone. Salesforce is still in the right ballpark and other SaaS companies typically dilute shares by at least 5% anyways, something that I am not considering here. In any case, Salesforce has other attributes that make it an attractive investment, attributes such as its history of steady revenue growth and free cash flow growth. Both factors suggest exceptional management.\n Stock Valuation The plot below illustrates how Salesforce stacks up against the other stocks on a relative basis based on forward EV/Sales versus forward revenue growth. Note: Please refer to a recent article for more information on the scatter plot relative valuation technique.  (Source: Portfolio123/private software) Salesforce is situated below the best-fit line on the scatter plot, suggesting that the stock is somewhat undervalued on a relative basis relative to its peers. Investment Risks It seems unlikely that we will see a vaccine until at least the spring of 2021 and that depends on everything going well in Phase 3 trials for vaccine candidates. Therefore, it will be at least a year (in my opinion) before we see a return to some kind of normalcy. While we wait, the government and the Federal Reserve are being generous with handouts and stimulus. But how long will this last? The handouts are a heavy burden for taxpayers, and I can’t see such handouts persisting for much longer, certainly not past the November election. When the handouts stop, I expect that the stock market may become very bearish. There are suggestions from critics that Microsoft (MSFT) Dynamics 365 is outperforming Salesforce in its own backyard and will in fact have more market share in Salesforce’s core market within three years. While it may be true that Microsoft is taking some market share, I am not seeing the evidence that Salesforce is in any trouble. \n (Source: Salesforce) Investors should always take such critical market share analysis with a grain of salt. The ultimate indicator, even if Salesforce is losing market share, is Salesforce’s revenue and free cash flow growth, and these fundamentals do not appear to be unduly slowing down by any significant amount beyond what should be expected over time for a high-growth company. Summary and Conclusions Salesforce has been in business for a long time. Through 21 years and two previous recessions, Salesforce has proven to be a SaaS cash machine. Salesforce is credited with introducing SaaS to the world and SaaS is now being replicated by almost all software companies with very good results. Salesforce sports an annual revenue growth of 30%, albeit fueled by acquisitions. Apart from the expected revenue growth, Salesforce has strong free cash flow and nearly $10 billion in cash and cash equivalents. As a leader (or perhaps the leader) in digital transformation, I expect that this company will navigate the pandemic successfully and still achieve double-digit growth in spite of the global recession. After all, the pandemic has accelerated digital transformation and Salesforce is a company that should benefit from this massive pandemic shift. We don’t know when the pandemic will subside, and we don’t know how the recession will play out, although it is very likely that it will be long and deep. Salesforce’s strong balance sheet and recent financial performance make it an ideal investment in today’s market. Given that Salesforce stock is undervalued relative to its peers and the stock is making a move to all-time highs, I am giving the company a bullish rating.\n\nDigital Transformation is a once-in-a-lifetime investment opportunity fueled by the need for businesses to convert to the new digital era or risk being left behind. And the pandemic has dramatically accelerated this paradigm shift. You can take advantage of this opportunity by subscribing to the Digital Transformation marketplace service. \n\nDisclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any 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.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":false,"deviceId":"web-server-community-laohu8-v3","version":"4.25.1","shortVersion":"4.25.1","platform":"web","vendor":"web","appName":"laohu8","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2057350223"}