Shares of customer relationship management (CRM) software company Salesforce (CRM 0.42%) are up 100% year to date in 2023, as of this writing. These returns have crushed the otherwise impressive 24% gain for the S&P 500. And the explanation for Salesforce's outperformance can be simplistic.
In the earnings call for the fiscal third quarter of 2024, co-founder and CEO Marc Benioff started his commentary liberally, using words like "unbelievable," "incredible," and "exciting." And he was largely referring to Salesforce's cash flow.
In Q3, Salesforce had an operating cash flow of $1.5 billion, up a stunning 389% year over year. And to be clear, the company's cash-flow growth isn't entirely recent. The trend has been ongoing for years and is a big reason Salesforce stock has been a winner, as the chart below shows.
CRM data by YCharts. TTM = trailing 12 months.
Could Salesforce's long-term cash-flow story continue in 2024 and beyond? Or will it come back down to earth? Well, the future is uncertain. But there are reasons to believe the company could keep gaining ground in the coming year. Here's why.
What's going right for Salesforce in fiscal 2024
In general, 2023 has been a difficult year for enterprise software companies. And Salesforce's revenue growth has admittedly slowed to an all-time low. But through the first three quarters of its 2024 fiscal year, the company's revenue is still up 11.3% from the comparable period of fiscal 2023, which isn't too shabby.
In recent years, Salesforce has acquired other software companies, including Slack and Tableau. The company's broader range of products is leading to more services being bundled and larger contract values with customers.
Accordingly, Salesforce's million-dollar deals were up 80% year over year in Q3. And with these bigger deals, the company's remaining performance obligations (future revenue from existing contracts) are also growing nicely. It ended Q3 with remaining performance obligations of $48.3 billion, up 21% year over year.
Give Salesforce's management a lot of credit. Some of its impressive cash-flow growth has been driven by exercising discipline on spending. Through the first three quarters of fiscal 2024, operating expenses were down 1.5% from the comparable period of fiscal 2023.
However, Salesforce's Q3 cash-flow performance was largely driven by higher-than-normal collections than what's customary during the third quarter. This is more of a timing issue than a material improvement to the business, which is something to be mindful of.
What's next for Salesforce?
Collections will vary from quarter to quarter, so this isn't a material part of the investment thesis for Salesforce. To grow cash flow, therefore, the company can grow revenue, cut expenses, or facilitate a combination of the two.
Looking at expenses, Salesforce is already putting up impressive numbers, so it feels greedy to expect it to do much more than it already is. Just look at the chart of the company's operating margin over the last decade.
CRM Operating Margin (TTM) data by YCharts. TTM = trailing 12 months.
Therefore, if it's going to grow cash flow, I believe it's more important for investors to think about Salesforce's revenue growth potential. And, as mentioned, there's reason for optimism.
Salesforce has been piloting new products built on its artificial intelligence (AI) software. But as of Dec. 14, it's making its AI generally available through a package called Unlimited Edition+ (UE+). UE+ plays on the current customer trend of bundling more Salesforce services into one contract.
According to management, Salesforce customers who switch to UE+ increase their spending by 70%. That is a huge revenue growth opportunity just within its current customer base.
In short, the trends regarding revenue growth in the coming year are in Salesforce's favor. The company's customers want to bundle more services, so it now offers UE+ to its entire base. And so far, customers switching to UE+ have spent significantly more money. If Salesforce's management can maintain financial discipline, it's very possible the company's cash flow will continue growing as it's done over the long term.
Currently trading at roughly 30 times its free cash flow, Salesforce stock isn't necessarily cheap in absolute terms. But the chart below does show that this is about the cheapest it's ever been.
CRM Price to Free Cash Flow data by YCharts.
In conclusion, it's unrealistic to expect Salesforce stock to double in value two years in a row. But on its current path, I believe it very well could deliver positive returns in the coming year and beyond, meaning its shareholders would do well to keep holding, even after the impressive gains in 2023.
