In 2022, Salesforce (CRM +2.12%) lost nearly half its value, making it one of the worst performers in the Dow Jones Industrial Index last year. However, if the stock was oversold, this year might see a strong rebound if the business stays intact.
But in the wake of the recently delivered news that Salesforce is planning significant layoffs, some investors might worry that this rebound won't happen. So is Salesforce slated to have a better 2023, or will the new year bring more of the same for shareholders?
Investors applauded Salesforce's layoffs
Salesforce didn't wait long to enact significant changes in 2023. On Wednesday, it announced plans to lay off approximately 10% of its workforce. Based on the company's most recently reported employment figure of about 80,000, around 8,000 workers are slated to lose their jobs.
Co-founder and CEO Marc Benioff took the blame for the layoffs, stating: "We hired too many people leading into this economic downturn we're now facing." Salesforce isn't the only tech company that has announced layoffs lately, and the decision was in line with a common theme: cost savings.
NYSE: CRM
Key Data Points
The market embraced the plan, with the stock rising about 3% the day it was announced. Usually, layoff news sends a stock down because it indicates business is getting tougher. However, that negative sentiment was already baked into Salesforce's stock price, so the market rewarded the company when it reacted to the shifting landscape.
So how might this affect Salesforce's financials?
A smaller workforce could lead to significant savings
With the company cutting 10% of its workforce, operating expenses will fall. It's unlikely the complete 10% will make its way through every operating expense, so let's say Salesforce saves 5% on its operating expenses. In its fiscal 2023 third quarter (which ended on Oct. 31), operating expenses were $5.289 billion. A 5% cut to that would bring operating expenses to $5.025 billion, a $264 million savings.
If all of that savings dropped down to the bottom line, it would more than double Salesforce's quarterly net income from the $210 million it delivered in fiscal Q3 2023 to $474 million. That's a huge deal because it would mark a slight rise from the prior year's fiscal Q3 net income figure instead of a drop. Although it is unfortunate that people are losing their jobs, this is the right business move for Salesforce.
So, could this move kick-start Salesforce's 2023 rise? I think it's likely. Based on two valuation metrics, Salesforce is trading at decade-low levels.
CRM Price to Free Cash Flow data by YCharts.
While a valuation of 25 times free cash flow is a bit steep, that number could dramatically improve if Salesforce's cost-saving measures trickle through. Additionally, the company hasn't fully optimized itself for profits yet, so its price-to-free-cash-flow ratio may be the wrong metric to use.
At 4.6 times sales, it's pretty clear Salesforce is undervalued, especially when you consider that Adobe, another large software company, trades at 9.1 times sales. (Adobe also trades at 21.7 times free cash flow and is optimized for profits). So what would a fair valuation for Salesforce be?
According to historical data, 8.1 times sales is pretty average for it, and also works well with the historical average of other software peers (like Adobe). Based on its current undervalued price-to-sales ratio, Salesforce has a 76% upside. That's not including its projected 11% revenue growth, so the real potential upside is even higher if it can return to a valuation in its usual range.
Very few stocks in the Dow Jones can rise 76% based on valuation alone. Throw in the company taking corrective actions to become more capital efficient, and you've got a recipe for a winner. Salesforce has a strong 2023 ahead, and investors shouldn't hesitate to take a position in the stock.
