The bears have been piling on to Salesforce (CRM 0.42%) as of late, and shares are trading down 48% so far this year. Pressure is mounting on the cloud software pioneer to pay more attention to profitability, and a number of executives have headed for the exit. Such things tend to happen at the end of an era -- in this case, an end to the easy-money economic policy era, as the U.S. Federal Reserve aggressively increased interest rates to try and fight inflation.
As ugly as 2022 was, though, the past thesis for why Salesforce was a buy is still valid for 2023 and beyond. Here are three reasons why.
1. The cloud is still in high-growth mode
Like many other software companies, Salesforce's growth was throttled by two related forces this year: the rapid rise of the U.S. dollar, and global economic uncertainty.
The record run-up in the dollar versus other currencies effectively lowers the value of a sale when that money is brought back to the U.S. for reporting purposes. In the last quarter, Salesforce reported year-over-year revenue growth of 14%, or 19% when excluding the effects of currency exchange.
For Q4, growth is expected to slow to 8% to 10% year over year, or 11% to 13% excluding currency exchange. Growth rates are decelerating because businesses around the world are getting cautious before shelling out cash right now. Inflation is still hot, there's still a war in Europe, and the Fed is still hiking interest rates.
The cloud is far from spent, though, and could dramatically pick up pace again later in 2023. According to researcher Gartner, total end-user spending on cloud computing could grow nearly 21% next year and surpass $590 billion in value. Where's that growth coming from? Well, IT sector spending overall is still a growth market, forecast to be up 5% in 2023 -- to $4.6 trillion. Basically, the cloud is taking a share of legacy IT overall.
Salesforce is huge, hauling in revenue of $30.3 billion over the last 12 months. Perhaps its days of consistent 20%-plus sales growth are over. But the pioneer of cloud software will still benefit from the rising tide that is the cloud for years to come. 2023 should be no exception.
2. The most important leadership is still there
I recently wrote how some key leadership is leaving Salesforce, including co-CEO Bret Taylor. Slack, which was acquired over the summer of 2021, is also losing its co-founder and CEO. Media outlets played up these departures, with some even claiming Slack was a disastrous takeover (which is utter nonsense -- Slack revenue just grew 46% year over year in the last quarter to $402 million).
To be clear, losing high-profile executive leadership isn't a good thing. However, such things happen, especially during times of big macroeconomic shifts like we experienced in 2022. Ultimately, the most important executive still leads the company: co-founder Marc Benioff. Chief Financial Officer Amy Weaver, who took over the role in 2021, is also still there and leading Salesforce into a new era where profit margins are given more attention (more on that in a second).
And though Salesforce is losing some of its younger executive talent, that doesn't mean the company will stop innovating. Benioff recently spoke about his commitment to continue delivering innovation to the Salesforce ecosystem. During that event, the CEO announced that Tableau (acquired in 2019) is now powering the Salesforce Data Cloud, making it easier for companies to visualize their information and helping reduce data storage costs for users.
This type of added IT flexibility and cost savings is why the cloud is overtaking overall IT spending, and I believe Salesforce can continue capitalizing on cloud industry expansion with Benioff still in the lead.
3. Profit margins have a long runway
Over the past decade, I've always focused on Salesforce's free cash flow generation -- and in particular its stellar free cash flow growth on a per share basis (which factors in dilution from employee stock-based compensation and acquisitions made using new stock).
Data by YCharts.
However, with the Fed ending super-accommodative money policies with its interest rate hikes this year, even free cash flow-per-share started to struggle. Plus, the market's focus turned to unadjusted net income (free cash flow is an adjusted profitability metric from GAAP, or generally accepted accounting principles). Even at this stage of its life, Salesforce generates a very small net profit. I've always believed Salesforce could meaningfully grow this metric when the time came to do so, and that net income would begin to converge with free cash flow. The time to do so is now.
I'm not alone in this belief. Equity investor and activist investor Starboard Value recently took a stake in Salesforce, citing its belief that unadjusted profit margins could meaningfully improve. Salesforce itself is also taking profitability more seriously as well, and is predicting profit margin expansion over the next three years. This year Salesforce started providing profit margin targets for the first time. It also initiated its first-ever share repurchase program, which returns excess cash to shareholders by reducing overall share count. Shares currently trade for just under 24 times trailing 12-month free cash flow.
Given these factors, Salesforce remains a core holding in my portfolio for the cloud software industry. The narrative has turned against the company, but I'm still a buyer for 2023.
