Salesforce’s (CRM) - Get Report blow-out earnings report lifted the stock to the upper stratosphere level and immediately prompted a stronger-than-expected environment for enterprise software more broadly. Software stocks, large and small, popped Wednesday after Salesforce’s Tuesday afternoon results.
Salesforce rose about 25% to $270 a share Wednesday, bringing the software giant’s market cap to above $240 billion, cementing its status as a welcomed new member of the evolving Dow Jones Industrial Average – effective on Monday.
Before we analyze, here were the earnings results against Wall Street estimates:
- Revenue: $5.15B v. $4.9B
- Subscription Revenue: $4.8B v. $4.62B
- Operating Margin: 28% v. 16%
- Earnings Per Share: $1.44 v. 67 cents
Management raised revenue guidance for the full fiscal year to $20.75 billion from $20 billion, which Canaccord Genuity analyst David Hynes wrote in note “reflects increased confidence” in the trajectory of the business.
Driving the revenue strength -- which can clearly be sustained at above a 20% growth clip -- was the pandemic environment, which forces businesses to operate from home, increasing the need to operate digitally and therefore store more data that way. That’s a narrative we’ve all heard of at this point in the year, but it’s driving tech companies to produce results far above expectations.
All product categories saw huge year-over-year increases, with platform revenue coming in at $1.5 billion, up 66% year-over-year. While it’s true that fewer business projects -- a theme in any recession -- puts pressure on sales, "a cloud accelerated COVID backdrop is putting further tailwinds in its deal momentum,” Wedbush Securities analyst Dan Ives wrote in a note. Mizuho analyst Gregg Moskowitz mentioned in a note that 7-figure deals Salesforce signed in the quarter grew 63%.
But the revenue beat and guidance raise, while certainly impressive, were only to the tune of several percentage points. Operating leverage was a key part of the story on the earnings print. And while EPS beat estimates by over two-fold, backing out an on-paper gain on an investment in a newly-public company, EPS would have come out to 87 cents, still 29% above estimates.
Analysts are raising near term earnings estimates by above 20% to well over $3.50 in most cases. But some analysts are raising their price targets by more than 20%; Canaccord’s Hynes raised his by 35% to $270 because he believes the stock’s multiple should expand as businesses adopt these types of services at a faster pace than previously anticipated. Hynes, like many, value Salesforce on a multiple of free cash flow because the company is squarely profitable, but many software companies aren’t, leaving price-to-sales a useful metric. Hynes cited "broad based multiple expansion across the software sector.”
As analysts adjust their revenue forecast, the stock now trades at 12.4 times management’s expected sales for fiscal 2021, which would make that multiple a hair lower on the next twelve months of the calendar. That’s a lower valuation than some of the smaller software players, but in-line with or a touch higher than Microsoft’s 2021 revenue multiple of 10 times.
For tech investors looking at a broad set of stocks, Salesforce's quarter provides context for a growth environment already gaining more appreciation just Wednesday. "Salesforce is probably the best barometer for cloud spending out there,” Wedbush’s Ives told TheStreet. "The Street [Wall Street] is reading through that, for software, the party continues,” Ives added, after having written in his note the results "should have broader implications across the software sector.”
Here’s how these smaller software names performed Wednesday:
Here’s how these large cap names performed:
There are some concerns, though. Salesforce is now trading near the higher range of its usual valuation for the past few years, and Mizuho’s Moskowitz indeed uses a slight valuation discount for Salesforce, which is now growing at a slightly slower clip than some peers.
And if businesses are adopting data storage and other related software services at a faster pace for the next few years, the market for the services may reach maturity sooner as well. And that, according to traditional company valuation, would pressure the latter years of Salesforce’s valuation. "The total addressable market is being accelerated and that’s overshadowing the fears of tougher comps when you look at later years,” Ives told TheStreet. “Ultimately, companies will have to navigate tougher comps [comparables] and the multiples will reflect that.”
Ives said he has made this adjustment to latter years, but that the tailwind in the shorter-run is outweighing this long-term concern.
Meanwhile, the U.S. market is starved for real return and will pay a premium for innovative tech companies that are proving to be the world's work-from-home savior. And that herd decision is only emboldened by the fact that nobody really knows when the pandemic will be over.