Stock Salesforce: Hard to find a better investment (NYSE: CRM)

Stephen Lam/Getty Images News

Investment thesis

Within the stock markets, it is very difficult to find large companies at low prices because generally these companies are bought by many investors who want to become their shareholders. For a large company to be undervalued an asymmetry of information is necessary: ​​all the parties involved in the negotiation do not have the same knowledge of this company.

In the case of Salesforce (New York Stock Exchange: CRM), I believe that is exactly what is happening: not everyone knows the potential of this company, and in this article, through objective and subjective data, I will try to explain why this company is dominant in its sector and why at this price it is a strong buy.

The reasons why I consider Salesforce a solid buy are many and they will all be discussed. The main ones are:

  • A huge competitive advantage
  • Solid and growing revenues
  • Substantial increase in cash inflows
  • Irrelevant debt
  • Sustainability and community engagement
  • The fair value is higher than the current price

Buying such a commercially, financially and socially dominant company at this price is not an opportunity that comes along often; therefore, I think this is potentially one of the best deals of 2022. The recent 40% drop should be seen as an opportunity to buy a big business at a discount, not a reason to stop trading. believe in Salesforce.

A dominant market share

The first thing to analyze when considering a large company is, in my opinion, its competitive advantage: a market with more competitors is a market that also reduces profit margins. In the case of Salesforce, it is no longer possible to determine exactly who its competitors are since this company holds a dominant market share.

Salesforce market share

Salesforce Market Share (Salesforce)

From what we can see in this photo, the competitors are too far from Salesforce’s market share, which, by the way, is increasing every year to their detriment. In addition, regarding the growing market share, Bill Patterson, Executive Vice President and General Manager of Salesforce, also said, “The most recent IDC figures show that more and more companies are looking to Salesforce as their business. choice each year. More than ever, organizations of all sizes and across industries need a trusted partner to help them navigate this digital world.”

Every business nowadays needs a CRM because it helps build better relationships with customers, increase sales and, therefore, profitability. A company with a good CRM is a company with better profitability and Salesforce is the #1 CRM in the world for the eighth consecutive year with an increasingly overwhelming dominance. To give you a better understanding of what competitive advantage we’re talking about, consider that in 2018, already 99 out of 100 companies on the Fortune 100 list were using Salesforce services.

In addition, a final consideration that reinforces the competitive advantage of Salesforce concerns the difficulty for companies to change CRM due to the time and cost of this process. Since CRM is the keystone of a company’s profitability because it contains within it a huge amount of data concerning the customer relationship, the company would never deserve to change CRM unless it is absolutely necessary. As Salesforce is by far the No. 1 CRM in the world, it is unlikely that a company that subscribes to Salesforce services will decide to do without it anytime soon since it has purchased the best CRM provider on the market.

Salesforce from a revenue perspective

Salesforce’s annual revenue grew from $1.6 billion in 2011 to $26.4 billion (28.8% CAGR), showing that the company has seen tremendous improvement from a revenue perspective over the past 10 years.

Income statement from 2011 to 2022

Income statement from 2011 to 2022 (TIKR Terminal)

As you can see from the graph above, there hasn’t been a single year where there hasn’t been a marked improvement in revenue and gross profit. The reason Salesforce revenue is so high is because most revenue comes from subscriptions that are continually renewed, while their growth is due to the structure of those subscriptions. The cost of subscription to Salesforce, as well as most CRM providers, is based on the number of users using it, starting with a minimum of five users. This means that if a company that subscribes to Salesforce increases its users, Salesforce’s revenue will increase accordingly: the growth of subscribed companies means that Salesforce itself will also benefit economically. Also, the other reason why revenue is growing so rapidly is obviously due to new subscribers increasing year on year. The structure of this business model is very advantageous, especially in the expansionary phases of the economic cycle, but less advantageous in the restrictive phases since the users could decrease and consequently also the revenues of Salesforce.

Finally, regarding the current macroeconomic scenario where we have very high inflation, I believe that Salesforce can pass any increase in operating costs on to the consumer since they have significant market power. Salesforce’s CRM provider is #1 in the world, and I personally don’t think subscribing companies aren’t willing to pay a slightly more expensive subscription.

Getting to this point though, a question arises, why does Salesforce have such low profits despite such strong revenue and gross profit? The answer lies in the costs of running the business.

Operating expenditures from 2011 to 2022

Operating expenses from 2011 to 2022 (TIKR Terminal)

As you can see from this graph, Salesforce is investing heavily to improve its services and build brand awareness. In fiscal 2022 alone, the company spent $4.46 billion on research and development and $11.85 billion on marketing and sales. These variable costs are deliberately kept high to further extend Salesforce’s competitive advantage. Today, management’s goal is not to achieve higher and higher profits but to gain an increasingly dominant market share and only then consider improving profit margins. The company’s cost structure, strongly oriented towards variable costs rather than fixed costs, allows it to implement this type of strategy; in the future, it will be enough to reduce the variable costs to have a significantly higher profit.

Finally, as further evidence of the strength of Salesforce’s activity in the graph below, we find its free cash flow from 2011 to date.

Free cash flow from 2011 to 2022

Free cash flow from 2011 to 2022 (TIKR Terminal)

Like revenue, Salesforce’s free cash flow follows the same upward trend, so this company’s cash inflow is substantial and growing. Yet another strength.

At this point, I would have liked to spend a paragraph talking about the debt of this company, but frankly, there wouldn’t be much to say since the debt is irrelevant. Net debt is only $3.8 billion, or $1.4 billion less than free cash flow for fiscal year 2022.

Sustainability and community engagement

The aspects discussed so far have highlighted the strengths of Salesforce from a quantitative point of view, but this company is much more thanks to its co-founder Marc Benioff. From day one of Salesforce’s birth, Marc Benioff decided that profitability and philanthropy would be the main linchpins of this company, and so the 1-1-1 model was born. This model aims to finance the general growth of the company by donating 1% of the capital of the company, 1% of its product and 1% of the time of the employees to the community: the objective is to stimulate the general development by the gift of a small portion of the company’s wealth. Through this initiative, Salesforce also co-founded Pledge 1%, a movement that encourages other companies to fund the general and sustainable development of society with minimal effort.

While 1% might seem like a small amount, it really isn’t since Salesforce has already donated a total of $532 million to the community, including $269 million in the last 3 years.

Where Salesforce donated

Where Salesforce donated (Salesforce)

Thanks to its charitable initiatives, Salesforce is one of the most valued companies in the world from a social and sustainable point of view. Below are some of Salesforce’s accomplishments.

Selling power

The achievements of Salesforce (Salesforce)

How much is Salesforce worth?

The valuation of Salesforce will be done through two different valuation methods: the discounted cash flow method and the multiple method. I personally believe this company is undervalued and now I’m going to show you why.

Multiples method

By this method, it can be seen that all the multiples considered are at levels below the historical average. I deliberately did not take into account multiples such as P/E and EV/EBITDA because, as I already explained in the paragraph concerning profitability, operating costs are currently deliberately high; therefore, the values ​​obtained would be misleading to understand the value of this business.

Valuation multiples

Valuation multiples (TIKR Terminal)

  • EV/Gross Profit is 9.18x when the historical average of the last 10 years is 11.31x
  • The market capitalization/FCF leveraged is 20.29x when the historical average of the last 10 years is 33x
  • EV/Revenue is 6.75x when the historical average for the past 10 years is 8.49x

I think this reduction in Salesforce’s multiples is unwarranted also given that the company’s future growth rate remains high. In fact, according to Marc Benioff, “As we continue to see tremendous customer demand, we are raising our FY23 revenue forecast to $32.1 billion at the high end, with a margin non-GAAP operating profit of 20%, and an operating margin and cash flow growth of 22% year-over-year.” Personally, I think the current price multiples are too low for Salesforce, so that’s the number one reason I think this company is undervalued.

Discounted cash flow

The second reason why I think Salesforce is undervalued is due to its fair value calculated through DCF. This model is structured as follows:

  • Free cash flow from 2022 to 2026 refers to TIKR Terminal analyst estimates since I consider them reasonable.
  • From 2027, the registered growth rate is 10%, i.e. less than half of what is expected over the first 5 years of the forecast.
  • Net debt and outstanding shares belong to TIKR Terminal.
  • WACC represents Salesforce’s weighted average cost of capital.

Discounted cash flow

Discounted cash flow (Sources already cited)

According to the parameters entered, the fair value of Salesforce is $304.90 while the current price is $175. Using a 30% safety margin to reduce estimation errors, the fair value is $213.43, still above the current $175.

Thank you for your attention.

Comments are closed.