The U.S. economy may technically be out of the COVID-19-induced recession (in strict terms, the period of time from the last peak of economic activity to the worst of the downturn) but a long road to full recovery lies ahead. A new era of digital-based operations is emerging, but even some of the companies helping with this "digital transformation" aren't yet free from the effects of the pandemic.
Enter salesforce.com (CRM -0.57%), which has been billing itself as a top software firm enabling said digital transformation. The company's fourth-quarter report card was solid, although some investors fretted over lower-than-expected profitability in the year ahead. CEO Marc Benioff has been clear in stating that now's not the time to focus on the bottom line. Given recent moves the company is making, I say now is the time to load up on the stock instead.
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It's the bottom line, dummy
Much of the angst surrounding Salesforce these days is regarding the pending acquisition of remote work and collaboration outfit Slack Technologies (WORK). Salesforce itself posted revenue growth of 24% in its 2021 fiscal year (the 12 months ended Jan. 31, 2021) and provided guidance of 21% growth in the year ahead. Not bad at all for a company expecting to haul in nearly $26 billion in revenue.
As many investors feared, though, Salesforce expects earnings per share to swing into the red this year -- in large part because of Slack. Specifically, amortization of purchased intangible assets (when a company realizes the cost of a purchase over time) and stock-based compensation will be responsible. Guidance for earnings per share for full-year fiscal 2022 is negative $0.44 to negative $0.42, compared to positive $4.38 for the just-completed fiscal year.
To be fair, Salesforce won't be bleeding cash. When backing out non-cash operating expenses like amortization and employee stock-based compensation, Salesforce generates healthy free cash flow (over 19% free cash flow margin last year even as Benioff and company ramped up spending during the pandemic). And though this metric will face some headwinds in the year ahead since Slack itself doesn't generate much free cash flow and Salesforce expects to keep spending to promote growth, the company's long-term track record of generating plenty of free cash flow per share expansion remains intact.
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A software platform for the future
The long and short here is that Salesforce's contracting profit margins are by design more than anything else. And it's also worth noting that despite the stellar revenue growth posted in the last year, this software firm wasn't exempt from disruption. Many of its customers (and prospective customers) were deeply impacted by the pandemic. Thus, I say 20%-plus revenue expansion in a period like we now find ourselves is pretty darn good.
But why the intentional spend-happy behavior amid a recession? Again, the Slack takeover holds the key. Benioff sees a once-in-a-lifetime change occurring in the years ahead, presenting an opportunity to capitalize on the standing goal to become one of the largest companies on the planet. The digital economy is quickly becoming the economy.
In its annual investor presentation, Salesforce cites a study from tech researcher IDC that predicts global spending on digital transformation will surge from $1.3 trillion in 2020 to $2.4 trillion in 2024. Salesforce has already built its software platform into a top-of-mind offering for enterprises trying to transition from legacy IT to a cloud computing-based model, and it thinks adding remote work capabilities from Slack will bring many more users to the Salesforce family (or Ohana, in Salesforce speak).
Viewed in terms of the total size of the pie up for grabs, Salesforce's goal to reach $50 billion in revenue by fiscal year 2026 (calendar year 2025) -- yup that's right, it hopes to double in size in five years -- doesn't seem so far-fetched. Of course, growth costs something, and Salesforce will go through some resulting growing pains like it is right now. Shares are down over 20% from their all-time high reached last summer before the Slack deal was announced.
Perhaps Salesforce stock had gotten ahead of itself last summer. But that doesn't mean it wasn't a good buy for the long haul then. And if you thought it was a good buy last summer, I think it's an even better buy right now (if you plan on holding for at least a few years). Shares trade for 48 times trailing 12-month free cash flow -- not the cheapest stock around, but not terrible considering the company is spending to capitalize on its ambitious plans. I'm adding to my existing position following the last quarterly update.
