Salesforce: Broke Key Support And Heading Lower

Investment Thesis

Salesforce, Inc. (NYSE:CRM) stock has been buffeted over the past year, as it lost 45% of its value from its 2021 highs. But, we think the battering was well-deserved as Salesforce is a business supported by low GAAP profitability, which the Street has continued to tolerate. Moreover, the execution risks through its acquisitive fervor have also been downplayed despite its low-margin business.

As one of the leading SaaS players focusing on CRM and cloud-based software, it has also been compared to the King of SaaS, Microsoft (MSFT), or even its creative peer Adobe (ADBE). But, if investors cared to focus on Salesforce's profitability, then it should be clear that CRM's stock still looks overvalued at the current levels.

Salesforce's Weak Profitability Complicated Its Integration

Salesforce's revenue growth rate has been impressive for a SaaS company that reported more than $26B in revenue for FY22 (its CY21). Co-Founder and Co-CEO Marc Benioff & Team has consistently registered above 20% topline growth over time, which surpassed Adobe and Microsoft over the past few years.

However, as seen above, such growth has come with a significant bottom-line impact. Keen investors should recall that Salesforce is still digesting its highly ambitious $27B Slack acquisition (completed in 2021). It also followed its vast $14.8B acquisition of Tableau in 2019 (completed in 2019). There were also other less significant acquisitions aside from these blockbuster deals. While such notable acquisitions have been accretive to its revenue growth, it hasn't shown up on its GAAP EBIT margins.

Salesforce usually guides for both its adjusted and GAAP operating margins. Therefore, observant investors can pore through its GAAP metrics and note that its EBIT margins have struggled, even though its adjusted margins have improved. For example, it reported 2.3% in FY22 but was still below its 2019 GAAP EBIT margin of 4%.

Nonetheless, management raised guidance for both its adjusted and GAAP margins for FY23. It guided an adjusted operating margin of 20% and a GAAP operating margin of 3.6%. Therefore, its guidance initially assured the market with its post-FQ4 earnings release in March. But, the stock has continued to fall since then.

CRM Stock Still Looks Expensive

We think it's critical for investors not to regard CRM with our preferred core software leaders, Microsoft and Adobe. Both its peers are highly GAAP profitable SaaS leaders, unlike Salesforce. As a result, investors should adjust their CRM stock exposure accordingly to reflect its relatively more expensive valuation.

However, if investors focused on its revenue multiples, they would have missed out on the significant growth premium asked on its weak profitability. For instance, CRM stock last traded at 5.4x revenue (5Y mean: 7.5x). But, it traded at a lofty 36.8x NTM adjusted P/E (5Y mean: 62x). Before we go further, investors must note that the P/E is predicated on its NTM adjusted EPS metric.

Then, the bifurcation became glaring when we compared CRM stock against ADBE and MSFT stock. CRM stock growth premium proved unsustainable as investors turned to highly GAAP profitable leaders. It's important to note that even ADBE and MSFT have been hit over the past few months, given their embedded SaaS premium. But the valuation gap between CRM stock and its peers has closed because its growth premium was unsustainable.

Moreover, when we pored over its GAAP EPS estimates, we noticed that it's significantly below its adjusted estimates and also estimated to drop in FY23E. As a result, the market may have been trying to price in Salesforce's weak profitability before it bottoms out moving forward.

However, if you value its NTM P/E based on its adjusted metrics, it could have led to an incorrect conclusion that CRM stock has moderated against MSFT. Note that Microsoft's FY23E GAAP EPS ($10.66) and adjusted EPS ($10.71) estimates are pretty close. So, we think investors are getting a high-quality P/E metric from MSFT.

But, if we used Salesforce's FY23E GAAP EPS in its P/E computation, it would have surged to 336.1x, compared to its NTM normalized P/E of 36.8x. Hence, investors need to be circumspect of using the right valuation metrics for CRM stock. Don't juxtapose it with ADBE or MSFT.

Is CRM Stock A Buy, Sell, Or Hold?

Therefore, we are not surprised that CRM stock has broken below its critical support level of $200, as seen above. As it headed lower, market makers also forced the selling to break below its critical 200-week moving average. While it remains a distance away from its COVID bottom, we aren't enthusiastic about adding as the market attempts its price discovery on CRM stock.

Therefore, we think the market has given investors a valuable lesson in pricing stocks like CRM, given its highly expensive GAAP P/E metrics. If you are looking for a safe tech harbor, CRM stock is unlikely to be one of them.

Nevertheless, given its oversold medium-term momentum, it's not an outright sell. Therefore, we rate CRM stock as a Hold for now.