For the better part of the past five years, Salesforce (NYSE:CRM) has been a big growth, cloud-based Customer Relationship Management (or CRM) company with improving margins and a stock price that has surged higher. Because of this, Salesforce stock has been a favorite among Wall Street analysts and investors alike.
But, the reality is that, despite this favoritism, Salesforce stock has gone nowhere over the past twelve-plus months. Back in September 2018, this was a $160 stock. Today, CRM stock also trades hands at $160.
Why has Salesforce stock gone nowhere? Three big reasons. Growth is slowing. Margins are stagnating. And, the valuation on CRM stock has been super rich, and didn’t account for slowing growth and/or stagnating margins.
Unfortunately, it looks like these same three factors will keep Salesforce stock stuck in neutral for the foreseeable future.
That is, growth projects to keep slowing, margins project to improve some (but not by much) and the valuation remains rich considering the company’s slowing profit growth trajectory.
All things considered, then, Salesforce stock doesn’t look too compelling here. Sure, it’s a great company with tremendous long-term growth potential. But, in the near-term, slowing growth and valuation friction may put a lid on CRM stock.
Growth Is Slowing
Salesforce is a big growth company. But, each quarter, it’s becoming less of a big growth company.
The numbers tell the story here. In the fourth quarter of fiscal 2019, Salesforce recorded a 27% constant-currency revenue growth rate. In the first quarter of fiscal 2020, the constant-currency revenue growth rate slipped to 26%. Last quarter, it dropped further to 23%. According to management’s guide, the revenue growth rate is expected to fall below 23% next year.
Yes, 23% is still a very impressive year-over-year revenue growth rate. But, it’s lower than 27%, and this steady slowdown implies that while Salesforce CRM cloud tailwinds remain robust, they are losing steam as the company gets bigger, runs up against tougher laps, and operates in a more saturated and competitive market.
At the same time, the margin expansion narrative is also losing steam. Throughout 2018 and the first half of 2019, Salesforce’s operating margins were powering higher at a steady rate. But, in the back-half of 2019 and the first half of 2020, Salesforce has had to significantly up expenses to fight off competition. Operating margins have consequently struggled to gain much ground during this stretch.
In other words, Salesforce is presently struggling with slowing revenue growth rates and stagnating margins. Ultimately, that means the profit growth trajectory here is flattening out. Sure, it’s still big — just not as big as it used to be.
Salesforce Stock Is Fully Priced
The problem with Salesforce stock is that it’s fully priced considering that the company’s profit growth trajectory is flattening out.
The numbers are easy to follow. Salesforce operates in numerous cloud CRM markets, the sum of which are growing at double-digit rates today and should sustain double-digit growth for the foreseeable future. Salesforce will maintain sizable share in these markets thanks to its strong product portfolio and impressive new product innovation. But, growth will slow as the laps get tougher, and as the market tailwinds taper off with increased market saturation. Consequently, Salesforce projects as a double-digit revenue growth company for the next few year … but not a 20%-plus growth company.
During that stretch, operating margins should improve slightly. Improving organic operating efficiencies as prior M&A noise phases out should drive nice margin improvements in fiscal 2021 and after. But, gross margins appear to be maxed out. And, with revenue growth slowing, positive operating leverage will be harder to come by, especially considering that Salesforce operates in an intensely competitive industry that requires big marketing, research and development expenses.
Putting all that together, Salesforce reasonably projects as a double-digit revenue grower with sizable (but not significant) upside margin drivers. My modeling suggests that this combo will drive earnings per share toward $6.50 by fiscal 2025, more than double the consensus fiscal 2020 EPS estimate.
Still, that isn’t enough growth to warrant much upside in CRM stock from current levels. Based on an application software sector-average 35-times forward earnings multiple and a 10% discount rate, that equates to a fiscal 2020 price target for Salesforce stock of roughly $155. That’s below where shares trade today, and we are only halfway through fiscal 2020.
Bottom Line on CRM Stock
Salesforce is a great company, and Salesforce stock is a great stock to own for the long haul. But, over the next few months, slowing growth trends coupled with valuation friction will likely limit upside in CRM. As such, while long-term optimism is warranted, so is near-term caution.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
