Salesforce Stumbles, But Investors Eye a Major Comeback

Salesforce’s (NYSE: CRM) Q3 and full-year revenue guidance were underwhelming, sparking a significant pullback in the share price that technology investors will want to take advantage of. Underwhelming is a relative term; in this case, it means that the guidance was as expected: sustained double-digit growth, margin strength, and robust cash flow drove its capital return. 

The capital return is among the reasons why long-term tech investors will be interested, and the stock price outlook is strong. The bad news is that the underwhelming guidance and impact on analyst sentiment may keep the stock price under pressure until later in the year.

Salesforce pays a token dividend that annualizes to less than 0.7% with the stock trading near long-term lows. The more significant portion of the return is share buybacks, which amount to more than five times as much on a dollar basis. 

The critical takeaways from Q2 are that the buybacks reduced the count by more than 1.1% on average for the quarter and 1.35% year-to-date, and they are expected to continue at a similar pace—if not increase—in the near future. The company’s growth outlook, cash flow, and new board authorization worth $20 billion may increase that pace. The latter lifted the remaining allotment to $50 billion, sufficient to sustain the Q2 rate for the next five years.

Salesforce Q2 Strength Overshadowed by Cautious Guidance

Salesforce had a solid quarter in Q2 with revenue growing by 9.8% as reported and 9% on a constant currency basis (CC). The top-line exceeded MarketBeat’s reported consensus by approximately 100 basis points, with strength seen in Data Cloud and AI segments. Subscriptions and Support, the primary category, grew by 11% and 9% CC, while Data Cloud and AI, the growth pillars, advanced by 120%. 

Margin is another area of strength that investors should focus on. The company is growing profitably and widening its gross and operating margins. The net result is a 30 basis point increase in net income to 18% of revenue and outperformance on the bottom line.

The adjusted EPS of $2.91 is more than a dime above forecasts, and strength is expected to continue through the year’s end. Although the revenue guidance was tepid, coming in as expected, the earnings guidance was improved to a range above consensus, with strength anticipated in Q4.

Among the critical details is a forecast for 12% free cash flow growth at the midpoint of the target range. 

Salesforce’s balance sheet underscores the business strength and reliability of the capital return. At the end of Q2, the highlights include fortress-quality leverage ratios, a net cash position relative to long-term debt, and rising equity despite the aggressive buybacks.

Equity is up incrementally, while treasury shares increased by 25% to over $24 billion. 

Salesforce Analysts Trim Targets: Range Narrows Around the Consensus

Salesforce analyst are lowering their price targets following the Q2 release and guidance update, but don’t read too much into the movements. The reductions narrow the range around the consensus price target, which forecasts a 35% upside from critical support targets.

Likewise, the institutional activity is robust this year and suggests solid support near September trading levels and the low-end of the analysts' target range. 

CRM’s price action pulled back following the update, but is unlikely to extend the move this month. The stock price is near the low end of the analysts' target range and support targets that have been confirmed numerous times, setting this market up to rebound.

The most significant risk is that CRM’s stock price will wallow near current levels indefinitely. However, that is not expected due to the growth and capital return outlook. The question is how long the stock will linger near its lows before analyst sentiment is reinvigorated and the rebound begins.

The most likely catalyst is the Q3 earnings results, which aren’t due until early December.

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The article "Salesforce Stumbles, But Investors Eye a Major Comeback" first appeared on MarketBeat.